HMRC is raising awareness of the tax treatment of termination payments related to Income Tax and National Insurance Contributions (NIC)
Several changes have been made to these rules over the past five years, which HMRC wants to remind accountants and employers to consider when finalising severance packages.
These include the introduction of post-employment notice pay, alignment of the rules for Income Tax and NICs, removal of foreign service relief on termination payments to UK resident individuals.
From 6 April 2020, a change in legislation introduced a Class 1A NICs charge on qualifying termination payments above the £30,000 exemption for tax.
From 2018, post-employment notice pay was introduced to ensure non-contractual payments in lieu of notice were subject to tax and NICs, the same as contractual and customary payments.
The amount within the termination payment calculated as post-employment notice pay, is now chargeable to Income Tax and NICs as general earnings, and no longer benefits from the £30,000 threshold available in section 403 Income Tax (Earnings and Pensions) Act 2003.
In addition, there is an alternative method for the calculation of post-employment notice pay, where an employee’s pay period is defined in months, but their contractual notice period or post-employment notice period is not a whole number of months.
Non-resident individuals are now charged to UK tax as earnings on the post-employment notice pay to the extent that they would have worked during their notice period in the UK. In the past, the post-employment notice pay of non-UK resident employees from UK employments, was not subject to UK tax as earnings.
It is also worth understanding that the foreign service exemption is no longer available for payments and other benefits that fall within s413 Income Tax (Earnings and Pensions) Act 2003, if specific criteria are met.
The exemption still applies if the individual is not a UK resident during the year of termination, or the individual is a seafarer and has sufficient seafaring service.
A termination payment may consist of different types of payments such as:
- Compensation for loss of office;
- Payment in lieu of notice;
- Damages;
- Redundancy;
- Holiday Pay;
- Retirement;
- Illness or injury of an employee; or
- Payment for a restrictive covenant.
These payments may be taxable as earnings under other provisions of ITEPA 2003.
If the termination payment is not taxable under the other provisions, it may be taxable as a termination payment under s401 ITEPA 2003. However, some payments such as those for an injury or illness or a payment of legal fees in respect of the termination may be exempt from tax.
If the wrong amount of tax and National Insurance has been paid, corrections can be made via a Full Payment Submission, using the ‘Data item box’ (Class 1A year- to-d date) for amendments to the Class 1A NICs.
