The tax treatment of termination packages is a complex issue. Paul Tucker explains why many firms could be due a NI refund.
If you can answer 'yes' to the following questions your firm may be entitled to a national insurance (NI) repayment.
- Have you made any termination payments (including redundancies) in the last six years?
- Have you made any payments in lieu of notice (PILON)?
- Did you subject those payments to tax and NI?
HMRC's £30,000 tax exemption
Most firms are aware of the £30,000 tax exemption for termination packages, but need to consider carefully how the package is made up. Broadly speaking, the exemption should be available to set off against any element of a termination package that is not:
- earnings (such as contractual payments, bonuses, holiday pay, etc)
- for a restrictive covenant, or
- a pension payment.
If the tax exemption is due, there will be no NI due (without limit). For example, if a payment of £50,000 is made and it does not fall within one of the categories above, £20,000 will be taxable, but there will be no NI on any of the amount.
Payment in lieu of notice
This is one of the most confusing issues. Tax and NI is due if the employee has a contractual entitlement to a payment in lieu of notice (PILON). This often applies to senior employees. Most employees will only have an entitlement to notice, rather than a payment in lieu of notice. Firms sometimes account for PAYE (tax and NI) on anything described as a PILON.
Firms may wish to take a cautious approach, but there is a potential cost. If your firm adopts the wrong treatment you may significantly overpay employer's NI (the current rate is 13.8%). It's also likely that you will deduct too much tax and NI from your employees.
Opportunities
There are two opportunities available to firms.
1. Future payments
You can obtain advance clearance from HMRC. For example, in a recent case we carried out a review where our client proposed to apply tax and NI to a non-contractual PILON and we concluded that the £30,000 tax exemption should apply. We then obtained HMRC clearance. Our client saved around £50,000 in employer's NI.
2. Repayments in respect of payments already made
All is not lost for payments already made and subjected to tax and NI. If a firm believes that a refund is due it can apply for a NI refund and it is possible to go back up to six years.
If you are about to make termination payments or redundancies, or have already done so and think you may be entitled to a refund, seek professional advice.
We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Holdings Limited 2013. code 1485/2013/db 13/1127 expiry 31/05/2014
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