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Considering the tax implications of redundancies

Crowe

With over nine-million employees and 1.2 million employers signed up to the furlough scheme, the government has moved onto the next stage of their jobs retention plan by introducing the Jobs Retention Bonus.

The bonus of £1,000 given to employers for every furloughed employee that is retained until 31 January 2021 and earns on average at least the Lower Earnings Limit (£520 per month) between 1 November 2020 and 31 January 2021.

While the bonus is welcome, many have criticised it for paying out to employers who would have likely retained the jobs anyway. More importantly, it has been criticised for not being a big enough incentive for employers to retain the jobs that they were already considering cutting. Whether this criticism is warranted or not, the likelihood is that the bonus will not be enough to save some jobs.

Redundancies are always a difficult topic of conversation, but the inevitability of the current situation means that there will be redundancies. In fact, there have already been reports of redundancies at some of the UK’s most renowned organisations. However, the last thing that employees and employers will want when going through this process is an unexpected tax bill.

Lessons need to be learned from the financial crisis back in 2008, when employers had to make redundancies when trying to manage through the recession. We saw from this that a large number of employers did not apply the correct tax and National Insurance Contributions (NICs) treatment to their termination payments with HMRC enquiries as a result.

While redundancies are predominantly an employment law issue, the several changes to the income tax and NICs treatment over recent years mean that special attention should be paid to ensure the tax and NICs position is correct.

Determining the tax treatment

It is easy to think of the £30,000 tax-free exemption for termination payments and assume that all related payments are tax-free up to this amount, without checking first whether the type of payment made qualifies for the exemption. However, the tax rules relating to termination payments are much more complex and require an examination of what the payment is actually for in practice.

The starting point for employers should be that the termination payment is subject to tax and NICs unless there is a certain exemption. To determine the correct treatment of the payment, it is important to separate out each element of the payment and to consider why it has been paid, including the below.

  • Is the payment linked to the employment (e.g. rewards or holiday pay) or other contractual clauses?
  • Is the payment for retirement?
  • Is the payment into a registered pension scheme?
  • Is the payment related solely to the termination of the employment (e.g. redundancy pay) or compensation for loss of office?
  • Is the payment in lieu of the employee working their notice period?

The tax and NICs treatment of each element of the payment will be determined by the answers to these questions.

In addition, if the employment is terminated before the end of the contractual notice period, a complex calculation must be performed to determine whether any of the payment is Post Employment Notice Pay (PENP), which will be taxable and subject to Class 1 NICs as general earnings.

Once all of these questions have been considered alongside tax legislation, employers can start to think about whether any amounts fall under the £30,000 exemption.

For NICs purposes, anything taxable as general earnings (including any PENP) will be subject to Class 1 NICs. However, from 6 April 2020, any other amounts subject to income tax (e.g. termination payments in excess of the £30,000 exempt amount) will also be subject to Class 1A NICs.

This illustrates the complexity of the tax and NICs treatment of redundancy payments. This is without considering how these rules interact with the Coronavirus Job Retention Scheme (CJRS).

On 21 July 2020, HMRC published draft legislation for further changes to the rules, which offer an alternative formula for calculating the PENP when the contractual notice period is not in whole months and brings the rules for non-UK residents working in the UK in line with those for UK residents.

It is important that employers are comfortable with ensuring the tax and NICs treatment of any payments are correct before taking these difficult decisions. If you would like to discuss the possible tax and NICs implications of making redundancies, please contact our Crowe specialists, Andy Hamman on 020 7842 5392 or Nick Irvin on 020 7842 5244.

Andy Hamman, Director, Employment tax, and Nick Irvin, Assistant Manager, Employment Tax
Crowe

For further information visit our Employers Advisory website page.