HMRC releases policy paper on changes to the treatment of termination payments

21 July 2020

HMRC has released a policy paper and draft legislation which discuss the changes to termination payments that employers make out to employees. The payment relating to the employee’s notice period, which is subject to income tax and both employee and employer National Insurance (NI) contributions is referred to as the Post-Employment Notice Pay (PENP).

There is an alternative PENP calculation if an employee’s pay period is defined in terms of months, but where their contractual notice period or PENP is not a whole number of months, but expressed in, for example, weeks.

The measure aligns the tax treatment of PENP for individuals who are non-resident in the year of termination of their UK employment with the treatment applied to all UK residents. At present, PENP is not chargeable to UK tax where an employee is non-resident within the tax year in which their employment terminates. Going forward, non-residents will be charged tax and NI contributions on PENP to reflect how this would have been treated had the individual worked in the UK during their notice period. The change only impacts those who physically performed the duties of their employment in the UK.

It is hoped that the legislation will remove unintended outcomes and bring fairness and clarity to the current rules surrounding termination payments, by ensuring that individuals are not treated less favourably in terms of tax on the basis of their contract or residency. The tax treatment of PENP will be aligned for UK and non-UK resident employees, and PENP from UK employment in respect of a notice period that would have been worked in the UK will be chargeable for all individuals regardless of where they reside.

In the Finance (No.2) Act 17, amendments were made to the taxation of termination payments, including:

  • The introduction of PENP, ensuring that all contractual, customary and non-contractual payments in lieu of notice were to be considered and subsequently, subject to tax and NI contributions
  • Removal of foreign service relief on termination payments to UK resident individuals – this measure does not apply to seafarers
  • Confirmation that the exemption for injury does not apply in cases of injured feelings
  • Alignment of rules for income tax and NI contributions, meaning that employer’s NI contributions are payable on qualifying termination payments exceeding £30,000. This was effective from 6 April 2020

The measure will take effect from 6 April 2021, and be applicable to individuals who have their employment terminated, where the termination payment is received on, or after, 6 April 2021.

 


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