PENP or PERP?

25 November 2018

This article was featured in the December 2018 / January 2019 issue of the magazine.

Duncan Groves, director and head of employment taxes at PSTAX, explains how new tax law has created unintended consequences and reveals employers need to be vigilant 

Apparently, according to dictionary.com, ‘perp’ is police slang for the perpetrator of a crime. After wrestling with the interpretation and ramifications of the PENP (post employment notice pay) rules, I’m beginning to wonder whether this is merely coincidental…

My colleague’s article on this subject printed in the September edition, alluded to the issue of the ‘relevant termination award’ (RTA) and its significance in the decision to use the formula to calculate a PENP or, alternatively, to ignore PENP and treat the termination payment as subject to the rules in section 401 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA): namely tax free up to £30,000 and, because it does not constitute earnings under the relevant social security legislation, also free from National Insurance contributions (NICs).

Of course, all readers will appreciate that a payment in lieu of notice (PILON) is a RTA. Nine months down the road from the legislation taking effect, it is well understood that its aim is to ensure that all PILONs are subject to tax and NICs, regardless of how they are ‘dressed up’. 

The new rules clearly exclude statutory redundancy pay from the definition of a RTA. The effect of this is for the statutory redundancy to bypass PENP and go straight to section 401 where it can be paid tax/NICs-free (barring the unlikely scenario that it exceeds £30,000). It would be logical for this same treatment to apply to all redundancy payments. Public bodies will always pay in excess of the statutory amount, but the non-statutory or ‘enhanced’ redundancy will generally be linked to a similar pre-determined formula relating to number of years’ service. It wouldn’t be possible for a public body to use the enhanced redundancy in any way to create a tax advantage, for example by offering it to an employee as a replacement for a PILON. So, it would seem perfectly reasonable for enhanced redundancy also to be excluded from the definition of a RTA.

...seem perfectly reasonable for enhanced redundancy also to be excluded from the definition...

 

Although our reading of the law and HM Revenue & Customs (HMRC) guidance indicated that non-statutory redundancy could not be so excluded, we were persuaded to put the matter to our HMRC technical contacts. See opposite page for what we got back. (The ‘EIM’ references and links are to content within HMRC’s Employment Income Manual.)

Hopefully you will be following the logic (and staying awake), but it is time to start putting together some scenarios and numbers so that the “unintended consequences” can be highlighted. Opposite are two case studies: the first describing a fairly typical scenario where there is a PILON; and the second the more likely scenario for a public body.

The somewhat unfortunate recipient of the £13,000, less around £1,700 tax/NICs, in case study B will not be overly impressed at having suffered this deduction, especially if s/he was not advised that this would be the outcome of the counter-notice. Perhaps, in such circumstances, the public body employer should consider making a PILON to the employee in respect of part of the unworked notice period so that the employee is not out of pocket. Alternatively, the employer should make it crystal clear to the employee that any counter-notice would give rise to a deduction of tax/NICs from the otherwise non-taxable, non-NIC-able payment of enhanced redundancy.

 

...public bodies have so far failed to appreciate this anomaly of the legislation

 

In either case, having awareness of the issue is clearly of paramount importance. The evidence of our various client communications, helpline emails, forums and training courses, etc, is that public bodies have so far failed to appreciate this anomaly of the legislation. HMRC compliance teams meanwhile are already on the prowl, as demonstrated by the recent mailing to all police and fire organisations requiring them to confirm that they have read, understood and are applying the PENP rules correctly. Are you? 

 

Response from HMRC

As per the changes introduced in April 2018, relevant termination awards are split into two categories, post employment notice pay (PENP) and payments that are subject to the £30,000 threshold available in s403 ITEPA.

So as a starting point, we would need to establish what a relevant termination award is. Relevant termination awards are defined in EIM13874 [https://bit.ly/2JlT8bm] so I’ll not go into further detail here. However, one point relevant to your query is that statutory redundancy payments (and contractually approved payments – see EIM13760 [https://bit.ly/2F8nxNe]) are not within the definition of ‘relevant termination awards’. So, these payments are always chargeable to income tax as specific employment income and benefit from the £30,000 threshold available in s403.

We then move onto the remainder of any payment made that constitutes a relevant termination award. Remember a relevant termination award doesn’t include any payments chargeable to income tax outside of Chapter 3 of Part 6 ITEPA (e.g. payments chargeable under s62, s394, s225 etc). The award would however include payments classed as non-statutory redundancy payments. We need to consider whether these relevant termination awards fall entirely, or in part, into one of two categories. This should be considered in the order they are presented here:

  •  post-employment notice pay (PENP)

  •  payments that are subject to the £30,000 threshold.

If there are no amounts of PENP, then the full amount of the relevant termination award amount is subject to the £30,000 threshold and is taxable under s401 on the amounts in excess of the threshold.

However, if there is an amount of PENP to account for, and no separate provision has been made to account for it, then the PENP will be accounted for first out of the relevant termination award made to the employee – even if this amount was provided as a non-statutory redundancy payment by the employer. Any amount remaining after accounting for the PENP will then fall into the second category listed above and will be taxable under s401 ITEPA on any amount paid in excess of the £30,000 threshold.

Adding to what I have said above, and in direct response to your query, any payments made to an employee as a statutory or non-statutory redundancy payment will not be included within the PENP calculation. As per EIM13775 [https://bit.ly/2JOpTiU], non-statutory redundancy payments continue to mirror statutory redundancy payments treatment – they continue to be treated as s401 ITEPA. However, because of the changes introduced in April 2018, if there is an amount of unaccounted for PENP, then if a non-statutory redundancy payment has been made, an equivalent amount of this non-statutory redundancy pay would be utilised to account for the PENP. 

Case study A

Employee’s position is made redundant on 18 June 2018.

Regular pay period and a notice period of one month.

Annual salary is £48,000 paid monthly (the employee receives no other payments and there are no salary sacrifice schemes).

The employee is due to receive a termination settlement of £17,000 comprising:

  • statutory redundancy pay of £3,000

  • non-statutory redundancy pay of £10,000

  • non-contractual PILON of £4,000 (as notice is not worked).

What is the value of the PENP and on what elements of the settlement of £17,000 are tax/NICs due?

PENP formula: (BP × D) ÷ P - T

(4,000 × 1) ÷ 1 = £4,000 – which is treated as subject to tax/NICs.

 The balance of the £17,000 payment, £13,000, is treated as non-taxable (as below £30,000) and not subject to NICs.

 

Case Study B

The employee’s position is made redundant on 18 June 2018. S/he is entitled to twelve weeks’ notice which runs from that date to 9 September 2018.

This notice period is paid via the payroll and is therefore subject to tax/NICs.

Annual salary is £48,000 paid monthly (the employee receives no other payments and there are no salary sacrifice schemes).

The employee gives counter notice and advises that s/he will now be leaving on 31 July 2018. As this reduces the payroll costs, the employer is happy to agree this.

Consequently, the employee is paid via the payroll until 31 July at which point s/he receives:

  •  statutory redundancy pay of £3,000

  • non-statutory redundancy pay of £10,000.

What is the value of the PENP and on what elements of the settlement of £13,000 are tax/NICs due?

As confirmed in the recent email from HMRC, there is a requirement to do a PENP as the employee has received a ‘relevant termination award’ and has unworked notice. These are the triggers for a PENP calculation.

PENP formula: (BP x D) ÷ P - T

(£4,000 × 40) ÷ 30 = £5,333, which is treated as subject to tax/NICs.

The balance of the £13,000 payment, £7,667, is treated as non-taxable (as below £30,000) and not subject to NICs.