There is a generous tax exemption available which allows up to £30,000 to be paid to an employee tax free in the event of redundancy.
However, not all payments made on redundancy qualify for this tax free treatment, those that do not qualify will be subject to income tax (PAYE) and National Insurance (NI) in the same way as ordinary salary payments.
It is important to consider all the different aspects of a redundancy payment, which may be made up of various components, each of which should be reviewed separately in regards to taxation.
Payments which are taxable:
- Payments of salary and benefits up to the date of termination will be taxable in the normal way, even if the employee is placed on Garden Leave.
- Payments made in recognition of past service e.g. terminal bonuses or the like, are also subject to PAYE and NI.
- Payments for entering into a restrictive covenant will again be subject to PAYE and NI.
- Payments in Lieu of notice (PILON) are taxable if:
- The employment contract includes provisions for a PILON (contractual obligation); or
- The employer habitually makes a PILON such that employees would automatically expect this (constructive obligation).
- Deemed pension contributions. If the employee is near retirement age then any termination payment could be construed as a payment to an unapproved/ unregistered pension and therefore taxable. HMRC clearance can be sought on this point.
Payments which can fall within the £30,000 exemption:
- Statutory redundancy payments.
- Enhanced redundancy payments, whether due under contract or discretionary, so long as they are genuinely paid in respect of redundancy and not in relation to past or future service.
- Additional payments for entering into a compromise agreement and forgoing possible claims against the employer (e.g. for unfair dismissal).
- Payments made as compensation for failure to undertake proper collective consultations in respect of redundancy.
- Payments made as compensation for breach of contract, e.g. a PILON where such is not permitted by the contract (no contractual obligation) and there is no history of habitual payment of PILON, which might create a constructive obligation.
It should be remembered that in addition to the tax considerations outlined above there are legal requirements connected with termination and redundancy. An employer should ensure they take advice on both the tax and the employment law aspects of this complex issue.