How much tax should employers deduct from termination payments? HMRC have announced a change to  the way that lump sum termination payments have to be taxed by employers from this coming April.

As is well known, the first £30,000 of a compensation payment can be paid free of income tax and national insurance contributions, provided that it is paid as compensation for “loss of office” or employment. This commonly applies on redundancy, but can apply in other situations too.

Any balance above the £30,000 is taxable at the employee’s marginal rate of tax.  This is because of a long established concession contained within ss.403 – 404 of the Income Tax (Earnings and Pensions) Act 2003. Useful links from the HMRC website are here and here.

Such payments are usually made once a compromise agreement or COT3 has been entered into  and the employee’s employment has terminated.  The compensation payment won’t have been included on the P45.  It is important that the payment must not be contractually binding, otherwise the tax concession is lost.  Most commonly this will affect those employees being made redundant.

Usually, the employer will deduct basic rate tax only from the balance and then to leave the employee to account to HMRC in due course for any higher or additional rate tax that might be due.   This can, depending on when the payment to the employee is made give them several months before that tax has to be paid – usually by 31st January following the end of the relevant tax year.

In these straitened economic times, HMRC has decided to clamp down on this practice and will, from April 2011, require employers to deduct basic, higher and additional tax from such payments.  The effect of this will be that higher and additional rate  employee tax payers will receive the net sum, rather than having to hold some of the payment back to pay their tax.

It will prevent them investing the higher or additional tax element themselves until they have to account to HMRC for it and pocketing the interest gained on it during that time.  The detailed guidance for employers will be published next month.

The taxation of payments on termination can be a complicated issue and I recommend that you take expert advice from a solicitor or accountant if you have any concerns.

Please note that nothing in this blog constitutes legal advice to you and is just my understanding of the law.  I only give advice via Dale Langley & Co and please do get in contact via michaelscutt@dalelangley.co.uk if you need some.

Related posts:

1. When is an Ex-Gratia Payment a Notice Payment?
2. What lies ahead in 2010?

Termination Payments: Taxing Times Ahead for Employers originally appeared on Jobsworth by Michael Scutt on 20/01/2011.

In a bit of a departure from normal practice here I am uploading a copy of a presentation I gave at the City Business Library today. It may be a bit cryptic if you weren’t there to hear it and please contact me if you require further assistance or explanation.  You can find it at my Slideshare site, which is here;

http://www.slideshare.net/michaelscutt/contracts-of-employment-201009f

Related posts:

1. Contracts of Employment: what you need to know
2. Harmonising contracts under TUPE
3. What Makes a Good Employment Law Story?

Contracts of Employment – what you need to know originally appeared on Jobsworth by Michael Scutt on 20/10/2009.