Now that the 2020/21 tax year has come to an end, there are a variety of tax filing obligations on employers. One of these obligations is…
As the Job Retention Scheme adopts a co-funding requirement and draws to a close in October, there will be a number of businesses that will need to consider terminating employment with some staff. It is widely assumed that as the business is struggling due to the Covid-19 crisis these terminations would automatically be classed as redundancy payments, but this isn’t necessarily the case. There are important distinctions to make and tax implications to be considered.
What is the difference between termination and redundancy?
Termination is the broader concept of bringing an employment to an end, with the various payments made to an employee on termination needing to be considered separately to determine the potential tax implications of each element of the payment. Redundancy is one possible reason or cause of termination, but a redundancy payment is only one part of the overall termination package given to an employee.
The types of payment which can form part of a termination package include:
- Payments in lieu of notice periods
- Holiday pay
- Payment in relation to a restrictive covenant
- Redundancy payments, both statutory and enhanced
- Payments connected to a company share or bonus plans
- Outstanding wages
- Payment for unfair dismissal
- Compensation for loss of employment
- Employer funded pension contribution
- Continuing entitlement to employer provided benefits
- Payments relating to a period of time spent working outside of the UK
What are the differences in tax treatment?
Each element of the termination package can have different tax implications and the important thing is to ‘get under the hood’ of the payment, understand what it is for and how that falls within the legislation. To illustrate this point, consider an employee receiving the following termination package:
- A payment towards a restrictive covenant, this would be liable to tax and national insurance
- A statutory redundancy payment which is exempt from tax, and
- An enhanced redundancy payment which is potentially exempt up to an overall limit of £30,000 which needs to be restricted for the payment made in respect of statutory redundancy pay
As highlighted in the above example, where the element of a termination package is either related to an enhanced (contractual or non-contractual) redundancy payment or a non-contractual compensation for loss of employment payment, it can benefit from an exemption for the first £30,000.
As of April 2020, as well as a tax charge on sums in excess of £30,000, there is also an employer national insurance charge due on the payments.
How is redundancy defined?
There is a strict definition on what qualifies as a redundancy, which is defined in section 139 Employment Rights Act 1996. Employers need to be able to demonstrate the payment is a genuine redundancy payment that falls within this definition. HMRC provides the following guidance on their approach to enforcing this and say:
“… an employee who is dismissed shall be taken to be dismissed by reason of redundancy if the dismissal is attributable wholly or mainly to:
- The fact that his employer has ceased, or intends to cease, to carry on the business for the purposes of which the employee was employed by him, or has ceased, or intends to cease, to carry on that business in the place where the employee was employed or
- The fact that the requirements of that business for employees to carry out work of a particular kind, or for employees to carry out work of a particular kind in the place where he was so employed, have ceased or diminished or are expected to cease or diminish”.
When does HMRC challenge the use of redundancy payments?
While a director can be made redundant in the same way as any other employee, it is particularly important to establish if their dismissal qualifies as a redundancy and in practice HMRC will pay particular attention to redundancy payments being made to directors.
In policing compliance with termination payments, HMRC look closely at the reason for each part of the payment. For example, if the employee being terminated (whether by redundancy or for some other reason) and they are retiring or nearing retirement age, HMRC are likely to scrutinise any payment. The employer may believe this payment falls within the £30,000 exemption as non-contractual compensation or as a redundancy payment. However, HMRC may argue it should instead be considered an employer funded retirement benefit payment, which would be liable to tax and national insurance as earnings.
It’s worth noting HMRC take a fairly ‘continental’ approach to retirement age and the guidance suggests they will attempt to take this point for payments made to employees who are over 55 years old. Clearly we are in unique times and, there may well be a stronger defence as to why it is a genuine redundancy case. This demonstrates the importance of understanding and evidencing the reason each element of the termination package being paid.
When looking at termination packages, it is often the case that the package will not simply be in the form cash. It may include a continuing benefit in kind provision, company assets transferring to the employee, lump sum payments to a pension scheme or payments towards reskilling the employee. While the nature of the payment still needs to be considered, each type of provision can have different tax consequences.
National minimum wage (NMW)
It is also important to be mindful of the NMW implications of terminating employees and particularly those who are salaried and have irregular working patterns. An employee who is paid at or close to NMW being terminated after having worked through the business’ peak season, may have been paid for less than NMW for the work undertaken in the year and the employer will need to do a ‘true up’ calculation on termination to ensure there is no NMW breach.
How we can help
The legislation and supporting HMRC guidance on the tax, national insurance and minimum wage implications of termination is not straightforward and PKF Francis Clark’s dedicated employer solutions team can support employers as they look to make termination payments to employees.