Changes to Termination Payment Taxation for Employers

By Graham | April 21, 2023

Mercian Accountants wants to remind UK employers of several changes to the tax treatment of termination payments. Over the past five years, the rules for income tax and National Insurance contributions (NIC) have been aligned, foreign service relief on termination payments to UK resident individuals has been removed, and clarification has been made that the exemption for injury does not apply to injury to feelings.

In 2018, post-employment notice pay was introduced to ensure that 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.

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. Additionally, non-resident individuals are now charged 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.

It is important to note 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 payment of legal fees regarding the termination, may be exempt from tax.

It is crucial that employers take extra care when making staff redundant and are aware of the new rules surrounding termination payment taxation to ensure they remain compliant with UK tax laws.

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-date) for amendments to the Class 1A NICs.

If you are unsure about how the changes in termination payment taxation affect your business, Mercian Accountants can help. Contact us for expert advice on navigating these complex tax regulations.