Termination payments in the UK fall into 3 categories:
- Fully taxable
- Partially taxable
- Fully exempt.
Fully taxable
If a termination payment (other than a redundancy payment) is given to the employee in return for services performed under the employment contract, the termination payment is considered earnings and is therefore taxable and subject to National Insurance Contributions (NIC) in full. This includes payments during garden leave and for restrictive covenant.
Partially taxable
If a termination payment is made outside the employment contract and is totally voluntary – i.e., the employee did not expect that they were to receive such a payment or the payment is redundancy pay, then it is treated as an actual termination payment and is subject to the £30,000 exemption. This exemption allows a termination payment to be made completely tax-free and without any NICs.
From April 2020, any payment above £30,000 is taxable on the employee, but only employer NICs are charged. The employer must make a one-off year-end reporting for any termination payments over £30,000.
Fully exempt
A termination payment made on the death of an employee is fully exempt from tax. Similarly, where the employment has been terminated due to the injury or disability of the employee, any subsequent compensation payment is exempt from tax.
If an employer makes a payment to a registered pension scheme as part of the termination package, this is also free of tax. Making a termination payment to such pension schemes rather than to the employee directly is very effective tax planning and is standard practice.
What if the termination is a result of the impact of COVID?
If your talent needs have changed significantly because of COVID and your employee’s job no longer exists, this may result in a redundancy situation. Eligible employers can claim funding for eligible employees’ wages from HMRC under the Coronavirus Job Retention Scheme. Eligibility and amounts reclaimable can be calculated via HMRC’s online tools available in the Job Retention Scheme sections on their website.
If made redundant, employees have certain rights and may be entitled to redundancy pay.
Employees have the right to:
- reasonable time off to look for a new job or arrange training
- not be unfairly selected for redundancy
- try out an alternative role for 4 weeks (or more if agreed in writing) without giving up their right to redundancy pay.
Employers should take the following steps to avoid compulsory redundancies :
- seek applicants for voluntary redundancy or early retirement
- seek applications from existing staff to work flexibly
- lay off self-employed contractors, freelancers, and other such workers
- avoid using casual labor
- restrict recruitment
- reduce or ban overtime
- fill vacancies elsewhere in the business with existing employees
- implement shorter working hours or temporary lay-offs.
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