From the 6 April 2018, the treatment of termination payments changed with the calculation of the Post Employment Notice Period ‘PENP’ becoming a legislative requirement in order to establish the correct tax and National Insurance treatment of payments being made. Furthermore, in April 2018 changes were also made to the availability of the Foreign Service Relief for individuals who have carried out all or part of their employment overseas, introducing a requirement whereby the individual must be non-UK resident in the year in which the termination takes place in order to benefit from the relief.
Since then, we have seen the introduction of Class 1A National Insurance due on termination payments which exceed the £30,000 exemption. This is an employer only liability which applies from April 2020 that must be captured through payroll and paid to HMRC along with the wider PAYE bill for the month the payment is made.
You may think these changes were enough and no further obligations could be imposed on employer’s surrounding termination payments, however HMRC have proved this wrong in their announcement in July surrounding further changes to come…
PENP Calculation - Recap
The PENP calculation is required to be completed by employers for all employee terminations where the employee does not work their full notice period as stipulated in their contract (or are statutorily entitled to if the contract is silent on notice) and receives compensation for termination of their employment.
As part of the calculation, the employer must identify the amount of basic pay that the employee would have received should they have worked their full notice period using the statutory formula to arrive at the PENP figure.
The value of the PENP calculation is then used to establish if any part of the termination package which would normally be covered by exemption falls into the scope of tax and National Insurance which must then be applied under PAYE at the point the payments are made. If the employer does not carry out the PENP calculation, this generates a risk that the termination payments may have been treated incorrectly for tax and National Insurance purposes, resulting in a PAYE failure by the Company. It is important to note that in the case of any PAYE failure, HMRC would look to recover any underpaid tax and National Insurance from the employer, not the employee, regardless of any indemnities included in settlement agreements.
The treatment of termination payments have become a key focal point for HMRC whilst undertaking employer compliance reviews, with copies of PENP calculations being requested as back up to the treatment applied. As such, it is vital that employers ensure they are fulfilling this obligation in all cases with relevant back up retained in the case of any future query from HMRC.
Following the changes from 2018 and 2020, HMRC have now announced plans to implement additional changes from April 2021 surrounding the tax and National Insurance liabilities where an individual’s employment is terminated whilst they are non-UK resident. These plans have come around as a result of the current PENP legislation stating that for years in which the employee is not resident in the UK, the PENP value is not considered taxable earnings for UK tax purposes, which HMRC view to cause inequality in the treatment of termination payments.
As such, from April 2021, HMRC is seeking to align the treatment of the PENP with the value calculated being subject to tax and National Insurance in the UK as if the employee had worked in the UK during their notice period, regardless of the individual’s residence status at the point of termination where the termination payment is received on, or after, 6 April 2021. The change only impacts those who physically performed the duties of their employment in the UK.
If you require any support or advice in structuring tax efficient termination packages or the completion of PENP calculations please contact Megan McDonald or your usual AAB contact.