The tax treatment of termination payments was reformed from 6 April 2018. Where an employment is terminated on or after that date, the approach is to compare the termination award to what is known as the ‘post-employment notice pay’ (PENP). The PENP is broadly the pay that the employee would have received had he or she worked their notice period. The termination award is taxed as earnings up to the level of the PENP and liable to Class 1 (employer and employee) National Insurance contributions. To the extent that the termination award exceeds the PENP, it is taxed as a termination payment, the first £30,000 of which is tax-free. Certain payments, such as redundancy pay, are always taxed as termination payments rather than earnings, regardless of whether the total termination award is more than the PENP; however, they count towards the £30,000 tax-free limit.
Up until 6 April 2020, if a termination payment exceeds the £30,000 tax-free limit, it is taxable but free from National Insurance contributions. However, this will change from 6 April 2020 and termination payments in excess of the £30,000 limit will become liable to Class 1A National Insurance contributions. However, as the charge is to Class 1A rather than to Class 1, the payment will remain NIC-free in the employee’s hands.
Unlike Class 1A NICs on benefits in kind, any Class 1A liability on termination payments will not be taken into account in computing the liability returned on the P11D(b); instead it will be reported and paid in year at the time that it arises through real time information (RTI). In this way, any Class 1A liability arising on the termination payment will be reported and paid in the same way and at the same time as the associated income tax liability. Regulations to give effect to the reporting and collection of the charge have been published for consultation.
It should be remembered that the Class 1A charge on taxable termination payments does not come into effect until 6 April 2020. Where the termination takes place before that date, there is no Class 1A to pay even if the taxable termination payment exceeds £30,000. Where terminations are on the cards, this provides clients with some scope to plan ahead – accelerating the termination date to before 6 April 2020 where feasible will save Class 1A NICs.