- Churchill Tax
Redundancy – Paying Off An Employee Safely
One of our subscribers is facing a bill for £5,000 in extra tax and NI as a result of not checking the small print in his own employment contracts. What caused this trouble and how could it have been avoided?
Redundancy pay
It’s fairly well known that where you pay an employee redundancy pay, the first £30,000 is tax-free. And, regardless of the amount, a payment of this type isn’t liable to employees’ or employers’ NI. But the rules regarding other employment termination payments can be more tricky.
A go-now payment
Depending on the redundant employee’s role in your company, you might want them to leave as soon as possible to avoid the risk of them stealing sensitive data or even sabotaging your business. However, if they’ve been employed by you for more than one month they’ll be entitled to a statutory notice period. You must pay them for this even where they don’t work it. Our subscriber’s problems stemmed from this situation.
Standard contract
When our subscriber’s manufacturing business started a decade ago employment contracts for the small workforce were drawn up with the help of an employment specialist. All workers at that time were director/shareholders and so, to avoid potential conflict in future if one of them decided to leave, a clause was included giving the company the right to ask them to go immediately in exchange for a payment in lieu of notice.
TRAP
This type of clause means the payment counts as employment income, i.e. earnings, rather than a payment relating to the termination of employment. Tax plus employees’ and employers’ NI will be payable.
The right clause for the job
Unfortunately, our subscriber took a one-size-fits-all approach to employment contracts. As the business took on more workers it used the same contract wording as that for the director/shareholders. So when it made three workers redundant, and asked them to leave before their notice was up as they were being disruptive, the payments relating to this period were liable to tax and NI.
Part of the redundancy
Our subscriber wrongly assumed the payments in lieu of notice now counted as part of the redundancy pay covered by the tax and NI exemptions and made no deductions for these. Consequently, HMRC is now demanding the tax and NI due. It says that the business was in error so it must pay rather than the former employees. Our subscriber could appeal, but we don’t think there’s much chance of success.
TRAP 1
If you’re unsure whether a payment connected to the termination of employment is liable to tax and NI, obtain advance clearance from HMRC.
TRAP 2
Check and, if necessary, amend your employment contracts so that they avoid the trap above. This can save you NI on payments in lieu of notice. For example, if you paid off an employee who was entitled to three months’ notice and who had a monthly salary of £3,500, this would save employers’ NI of £1,449 (£3,500 x 3 x 13.8%).
Conclusion
Payments in lieu of notice are usually tax and NI-free. But where the employment contract says you can pay off an employee without them working their notice period, this will make the payment liable to both NI and tax. Consider whether existing contracts need a pay-off option, and remove it if they don’t.