Amendment to the PENP calculation for termination payments

With so much focus on the extension of off-payroll working to the private sector, along with the continuation of the Coronavirus Job Retention Scheme, I guess it’s hardly surprising that two changes to the calculation of termination payment rules from 6 April 2021 have slipped under the radar.

The rules governing the taxation of termination payments were often regarded as complex with a loophole which enabled employers to take advantage of an employer NICs exemption by giving employees a non-contractual payment in lieu of notice (PILON), classing it as a payment for breach of contract and as such, the first £30,000 was exempt from income tax and the whole payment was exempt from NIC.  

Following the introduction of the Post Employment Notice Payment (PENP) in 2018, this is no longer the case and the tax and NIC treatment of termination payments now falls into three main categories:

• Payments relating to an employee’s notice period or which are derived from the contract of employment are taxable in in accordance with the PENP provisions and subject to Class1 NICs
  
• A relevant termination award of up to £30,000, which includes the Statutory Redundancy Pay, and compensates the employee for the termination of their employment can be made without being liable to income tax or NICs
  
• Any part of the termination payment that exceeds £30,000 is liable to income tax and the employer must pay Class 1A NICs

Further changes from 6 April 2021

The Government has now announced two changes to the PENP which took effect from 6 April 2021. 

Until 6 April 2021, PENP of non-UK resident employees from UK employments was not subject to UK tax as earnings.  However, the rules have been amended meaning that PENP of non-UK resident employees from UK employments is now subject to UK tax as earnings, to the extent the non-UK resident employees would have worked their notice periods in the UK, thus aligning the position for UK and non-UK resident employees.

The second change is to the formula for calculating the PENP.

PENP is calculated using the following complex formula:

((BP x D) ÷ P)-T

BP is the employee’s basic pay in respect of the last pay period ending before the ‘trigger date’. The trigger date is the day that notice is given, if no notice is given the trigger date is the last day the individual was employed;

D is the number of days in the post-employment period;

T is any payment or benefit received in connection with the termination of the employment which is taxable as earnings.

P is the number of days in the employee’s last pay period, ending before the trigger date.  However, since October 2019, HMRC has allowed employers to use the average number of days in a month (30.42, i.e. 365 ÷ 12) for P rather than the actual number of days in the pay period where the employee’s salary is paid by 12 equal monthly instalments and this alternative methodology is in the employee’s favour. 

This alternative methodology has been placed on a statutory footing since 6 April 2021.