What tax is due on redundancy payments?
Oct 08, 2020
Business Advice Tax Tips
The economic fallout from the coronavirus pandemic means that more businesses than usual are currently facing the difficult decision to make staff redundant. And if complying with all the aspects of employment law wasn’t hard enough, as an employer you also need to be aware of the tax and National Insurance (NIC) implications of making redundancy payments.
New rules were introduced in April 2018, and then again in April 2020, which changed the way income tax and NICs need to be calculated. The process is now more complex, more expensive to you the employer, and less generous to your employees.
It is often assumed that redundancy payments are tax-free up to £30,000, but this is not strictly true. Not all payments count within this £30,000 allowance – the tax exemption only applies to redundancy payments. Other payments, that are payments of earnings, are still subject to tax and NICs.
Two categories of payments
Payment of earnings includes all the general employment earnings that your employee would normally receive. This covers any outstanding wages, any payment in lieu of notice (PILON), or any holiday pay for example. It also includes payments to cover benefits in kind, such as the cash value of a company car or laptop. Much of this money is referred to as post-employment notice pay (PENP) – it is all subject to income tax and NICs, and does not qualify for the £30,000 tax exemption.
Redundancy payments on the other hand, are statutory or contractual payments made to your employees as compensation for their loss of employment or a failure to give proper notice. These payments are not earnings, and qualify as being tax-free for both PAYE and NI purposes up to £30,000 – but only to the extent that this allowance has not already been used up by taxable earnings. Beyond the £30,000 limit all payments are taxable.
Employer NIC liabilities
Employees have long since been required to pay income tax on any payments in excess of £30,000. They are not required to pay NICs on this excess though, and until April 2020, neither were employers.
However, in April 2020 the law changed and as an employer you are now required to pay class 1A NICs on any redundancy payments in excess of £30,000. Class 1A NICs are due at 13.8%, which means that in some cases making redundancies has now become far more expensive.
Other class 1A NICs which are associated with taxable P11D benefits, are payable once a year – either on 19 or 22 July following your tax year-end. Conversely, class 1A NICs associated with redundancy payments are deducted through real time information (RTI)/PAYE at the time of the actual termination payment, which can cause additional pressures with cash flow. And beware – if your liabilities are not paid on time or correctly, HMRC can charge you late payment interest or penalties.
Once you’ve established the correct tax and NICs due on all elements of your employee’s redundancy payment package, make a note of the timings when the payment is made. If you make a payment after your employee has already received their P45 this is particularly crucial. You’ll also need to take care when reporting the payment to HMRC, because different elements of the payment such as cash and non-cash benefits cannot be treated in the same way.
Redundancy and the CJRS
As a result of the Coronavirus Job Retention Scheme (CJRS), the government has introduced new legislation to ensure that employees receive their statutory notice payments and redundancy payments based on their normal rate of pay at the end of July 2020, before part-time furloughing was introduced.
You are entitled to consult with employees while they are on furlough about redundancy. If you have served notice of redundancy on an employee, you can still make a furlough claim during their statutory notice period until the end of October, while they remain employed and on furlough.
Navigating the rules of redundancy can be a legal minefield, so it’s important to get expert advice and follow the correct consultation procedure to ensure you protect your employees’ rights.
If you’re facing the need to make redundancies and would like to discuss the tax and NIC implications, along with the impact of the CJRS, please do contact us and we’ll be happy to help. Understanding how to correctly treat redundancy payments is an important part of taking these difficult decisions.