This article is divided into Eight Parts for easier reading:
- Part 01: Background.
- Part 02: Redundancy Pay and Taxes.
- Part 03: Redundancy and Consultation.
- Part 04: Suitable Alternative Work and Finding Other Work.
- Part 05: Redundancy and Other Factors.
- Part 06: Redundancy and Insolvency.
- Part 07: Directors.
- Part 08: Miscellaneous.
Part 02: Redundancy Pay and Taxes
- Redundancy pay is compensation for your job loss and, as such, up to £30,000 of it is tax free.
- This applies to a statutory or non-statutory payment, because the payment is regarded as a compensation payment.
- However, there is a distinction to be made; the £30,0000 exemption only applies to payments made on the termination of employment that are not payments of earnings (Section 2.13).
- Therefore, when structuring a termination package, employers should try and make best use of the £30,000 exemption by making compensation payments rather than payments of earnings where at all possible.
- With this in mind, care should be taken when drafting an employment contract.
- You are entitled in law to a redundancy payment if you have worked continuously for your employer for two years or more and are being dismissed for redundancy. You cannot be made to give up or ‘sign away’ that right, no matter what your employment contract states.
- Each element of the payment must be considered separately, rather than ascertaining the tax position of the payment as a whole.
- Careful analysis of the nature of a termination payment is crucial, as this will determine its tax treatment.
2.1 Different Terms for Redundancy Pay
Redundancy Pay can also be known as:
- Relevant Termination Award (RTA).
- Statutory Redundancy Pay (SRP).
- Non-Statutory Redundancy Pay (NSRP).
- Contractual Redundancy Pay (CRP).
- Enhanced Redundancy (ER).
- ‘Ex gratia’ or Non-Contractual Redundancy Pay (NCRP).
- Severance Pay/Payment or Enhanced Severance Payment.
- Compensation Payment.
- Compensation for Dismissal.
- Golden Parachute.
- Redundancy Money.
- Termination Pay/Payment.
- Discontinuance Wage/Payment.
- Dismissal Wage/Payment.
2.2 Types of Redundancy Pay
There are two types of redundancy pay:
- Statutory Redundancy Pay (SRP):
- Paid by the employer or government (if the employer is unable to pay, e.g. because it is insolvent).
- Statutory, meaning compulsory not optional.
- Non-Statutory Redundancy Pay (NSRP):
- NSRP replaces SRP altogether (you cannot get both).
- By law, NSRP must be more generous than SRP, otherwise SRP applies (i.e. an employer can pay more but not less).
- What you are entitled to will be outlined in your employment contract.
- May not be in your employment contract, but can be used as an incentive to encourage volunteer redundancies, for example.
There are a number of reasons why an employer would offer NSRP, including:
- Maintaining a reputation as a good employer;
- Preserving the goodwill of departing employees;
- Keeping up morale and preserving the goodwill of remaining employees;
- Matching market rates or industry norms for such payment; and/or
- Getting departing employees to sign an agreement saying they will not take legal action against their former employer (Section 5.2).
2.3 The Two Elements of Termination Pay
From 06 April 2018, The Finance (No.2) Act 2017, Section 5, essentially split termination payments into two elements (together termed Relevant Termination Awards, RTA):
- The first element is known as ‘post-employment notice pay’ (PENP).
- PENP represents the amount of basic pay the employee will not receive because their employment was terminated without full or proper notice being given.
- This element will be subject to income tax and employee Class 1 NICs.
- The legislation sets out a complex statutory formula to calculate the rest element of the payment, which involves carrying out a number of preliminary calculations to establish the employee’s basic pay, the amount of the notice period outstanding following the termination date and the number of days in the employee’s last pay period.
- Once PENP has been calculated, any contractual PILON payment (Section 2.16) can be deducted, to give the final taxable sum.
- The second element is the remaining balance of the termination payment.
- RTAs subject to section 403 ITEPA 2003 – these are eligible for the termination related tax exemptions.
- The balance of the payment is tax free up to £30,000 (provided that it represents income from employment).
- Any excess over £30,000 will be subject to income tax.
- Employees will continue to benefit from an unlimited NI exemption for payments related to the termination of employment, so the whole of the balance of the payment will be free from Class 1 NICs.
Things to Consider:
- RTA constitutes termination payments and benefits which meet all of the following criteria:
- The payments, or benefits fall within section 401(1)(a) ITEPA 2003 (i.e. they are received directly, or indirectly in consideration of or in consequence of, or otherwise in connection with the termination of a person’s employment).
- The payments, or benefits are received on or after 06 April 2018.
- The employment was ended on or after 06 April 2018.
- The payments or benefits are not statutory redundancy payments, or approved contractual payments to the extent that they are exempt under section 309 ITEPA 2003 (refer to EIM13760).
- The payments or benefits are not chargeable to income tax by virtue of any provision other than in Chapter 3 of Part 6 ITEPA 2003 (refer to EIM13000).
- Where notice has not been paid and/or taxed separately, compensation payments now need to be divided up into an amount representing notice pay and the remainder of the payment (as above).
- Importantly, these new rules did not apply to SRPs (not an RTA), which could still be made tax-free in their entirety.
- Although HMRC guidance had previously suggested that NSRPs would also be excluded from the these rules, this was been amended and the reference to NSRP removed.
- Enhanced redundancy payments do count as an RTA and therefore do not automatically benefit from the £30,000 exemption.
- Whilst these rules did little to simplify the current regime for employers and employees they certainly generated additional revenue for the Treasury by making many more termination payments subject to some element of tax.
- From April 2020, Class 1A NICs are payable on non-contractual termination payments that exceed the £30,000 threshold and are not already subject to Class 1 NICs.
- Restrictive covenants are not considered RTA.
2.4 What is the General Difference between SRP and NSRP?
- Statutory redundancy is the amount which must be paid by the employer to the employee under employment law and will be a fixed amount for each year of service.
- An employee may also be entitled to a redundancy payment in accordance with the express terms of the contract of employment or they may be able to claim an implied contractual right where the payment of a specific amount on redundancy by an employer has become contractual through custom and practice.
- An employer may also offer a NSRP where no scheme is in place.
- An employer may refer to this as ‘enhanced redundancy’ and it is common to have an enhanced redundancy policy in place.
- Where an employer’s redundancy policy is stated to be discretionary, the contractual position will need to be carefully checked.
- Where it is (or could be considered) discretionary, things an employer should consider include (refer to Park Cakes Ltd v Shumba & Ors  EWCA Civ 974):
- On how many occasions it has been paid?
- Over how long a period has it been paid?
- Are the benefits always the same?
- Are the benefits always calculated the same way or on a case-by-case basis?
- To what extent are the benefits publicised generally?
- The above can lead to implied terms through custom and practice.
- How are the terms described? Wording such as ‘discretionary’ and ex-gratia’ aid employers.
- What is stated in the express contract? Is there a specific clause stating there is no entitlement to an enhanced redundancy payment?
- Is there equivocalness in the contract? The employee must demonstrate that the entitlement is contractual, rather than it might be.
- Failing to pay enhanced redundancy when a contractual obligation has been identified is a breach of contract.
- It is clear that if the employer has any discretion to exercise under the enhanced redundancy scheme then that discretion must be exercised in good faith and the employer will not be entitled to exercise its discretion in a wholly unreasonable, capricious or arbitrary manner.
- It is not uncommon for employers to require employees to enter into settlement agreements (whereby, an employee waives specific claims against an employer) in return for a NSRP (Section 5.2).
- Generally, NSRP packages tend to follow the same principles as SRP entitlements, as departing from the statutory criteria could invite allegations of discrimination.
- They generally have the same qualifying criteria, such as the age banding; offering enhancements as a multiple of the SRP entitlement.
- For example, a NSRP package may offer three weeks’ pay but the SRP entitlement is one weeks’ pay.
- Some NSRP packages may extend eligibility criteria, such as employees being able to apply with only one year of service instead of two.
2.5 What about Contractual Redundancy Pay Specifically?
- An employer could be contractually obliged to make an additional redundancy payment.
- This obligation could arise from:
- The written contract of employment;
- A collective agreement with a trade union;
- A letter given to employees (perhaps as a loyalty incentive in uncertain times); or
- As an implied contractual term through custom and practice (however, this is much more difficult for employees to establish than is often thought to be the case).
- There may be a policy of paying enhanced redundancy payments which is not contractual.
2.6 What about Non-Contractual Redundancy Pay Specifically?
- An employer may choose to pay an enhanced redundancy package for a variety of reasons (refer to Section 2.2).
- When fixing or agreeing an enhanced package, regard should be had to other relevant laws including discrimination laws – the age discrimination law in particular.
2.7 Do I Qualify for Redundancy Pay?
To be eligible for SRP you:
- Need at least two years continuous service with your employer; and
- Must be over the age of 18 but under the age of 65 (before dismissal).
2.8 What about Short-Term and Temporary Lay-Offs?
You can claim SRP if you are eligible and you have been temporarily laid off (without pay or less than half a week’s pay) for either:
- More than 4 weeks in a row; or
- More than 6 non-consecutive weeks in a 13 week period.
Things to Consider:
- Write to your employer telling them you intend to claim SRP. This must be done within 4 weeks of your last non-working day in the 4 or 6 week period.
- If your employer does not reject your claim within 7 days of receiving it, write to your employer again giving them your notice.
- Your claim could be rejected if your normal work is likely to start within 4 weeks and continue for at least 13 weeks.
2.9 Who Does not Qualify for Redundancy Pay?
You will not qualify for SRP if:
- You are self-employed or a member of a partnership.
- You are a director who has a controlling interest in the company.
- A member of certain professions, including the Armed Forces, police, parliamentary staff, and Crown servants.
- Your employer offers to keep you on.
- Your employer offers you suitable alternative work which you refuse without good reason.
- You were dismissed for misconduct.
- You are a former registered dock worker (covered by other arrangements) or share fisherman.
- You are an apprentice who is not an employee at the end of your training.
- You are a domestic servant who is a member of the employer’s immediate family.
- You leave before the end of your notice period without permission from your employer.
2.10 What Notice Pay Can I Expect?
As well as SRP, your employer should either:
- Pay you through your notice period; or
- Pay you in lieu of notice (Section 2.16) depending on your circumstances.
Your notice pay is based on the average you earned per week over the 12 weeks before your notice period starts.
Things to Consider:
- During your notice period you are entitled to the same pay you would normally get, and this includes if you are:
- On holiday (annual leave);
- On sick leave;
- On maternity, paternity or adoption leave;
- Temporarily laid off; or
- Available for work but there is no work to do.
- The period of paid notice you are entitled to will be your statutory period of notice or the period of notice set out in your contract, whichever is the longer.
- If you are on reduced pay because you are absent due to sickness, or because you are on maternity, adoption or shared parental leave, where the employer gives you statutory notice, you are entitled to full pay while working out your notice, even if you have already used up all your entitlement to paid leave.
- The rules are different if you are entitled to notice that is a week (or more) longer than the statutory period of notice.
- Here, if you are off work during your notice period, your employer only has to pay whatever statutory or contractual sick pay or maternity, adoption or shared parental pay you are entitled to.
- If you have already used up your whole entitlement, your employer may not have to pay you anything during your notice.
2.11 What Redundancy Pay Will I Receive?
The SRP you receive is based on your:
- Age (18-65);
- Length of service (capped at 20 years); and
- Salary (with a maximum award of 20 week’s pay).
- Your weekly pay is the average you earned per week over the 12 weeks before the day you got your redundancy notice.
- If you were made redundant on or after 06 April 2022, your weekly pay is capped at £571 and the maximum statutory redundancy pay you can get is £17,130.
- Weekly pay is subject to an annual uprate on 06 April each year.
As of April 2022, the limits were:
- For ages between 18 and 21, you will receive 0.5 week’s pay for each complete year of service.
- Between 22 and 40, you will receive 1 week’s pay for each complete year of service.
- Between 41 and 65, it is 1.5 week’s pay for each complete year of service.
Things to Consider:
- For the purposes of calculating redundancy payments, weekly pay is capped which is bad news for those who were earning more.
- Redundancy pay is free of tax and national insurance (NI) as long as the award you are entitled to does not exceed £30,000.
- Beyond this threshold payments will be subject to tax deductions at the normal rate.
- Anything else you receive as part of a redundancy package which is not money will be converted into a cash-value for tax and NI purposes.
- Non-cash benefits will also count towards the £30,000 tax-free limit.
- Anyone who volunteers for redundancy is still eligible for SRP.
2.12 When Will I Receive My Redundancy Pay?
- An employer must pay redundancy on an employee’s last day.
- The employer can pay shortly after, on a set date, if both the employer and employee agree in writing.
- The employer should clearly communicate when and how the payment will be made.
- For example, let employees know if payments will be included in their monthly pay or as separate payments.
If making redundancy payments puts the business at risk, the employer can ask the Redundancy Payments Service (RPS) for ﬁnancial help. If the employer is insolvent (Part Six) they can get RPS to make redundancy payments and recover the debt from the employers assets.
2.13 What is Meant by Payment of Earnings?
- These are payments normally made as part of the employment, i.e. wages and salary.
- They are not the same as a statutory redundancy payment, which is made on termination to compensate the employee.
- The statutory redundancy payment itself is tax free, but other payments of earnings will not be, with examples including:
- Payments in lieu of notice (Section 2.16);
- Holiday pay;
- Overtime and bonuses; and
- Other benefits.
- Section 401 of ITEPA 2003 is widely drafted and is designed to catch all payments and benefits that are not earnings.
2.14 What about Tax and National Insurance?
If you are made redundant, you may get a ‘termination payment’, which can include:
- SRP (under £30,000 is not taxable);
- Holiday pay;
- Unpaid wages; and
- Company benefits, for example bonuses.
What you will pay in tax and NI on depends on what is included in your termination payment.
- What you will pay tax and NI on:
- Holiday pay;
- Unpaid wages
- Payments you get from your employer for agreeing to enter into a restrictive covenant; and
- Any payments you receive instead of working during your notice period – this may be payment in lieu of notice (PILON) or be part of any severance pay.
- What you will not pay tax and NI on:
- Contributions your employer makes to a registered pension scheme as part of your termination payment – you will pay tax on any employer contributions that go above the Annual Allowance.
- Legal costs related to the settlement that your employer pays directly to your solicitor.
- A termination payment you get because of an injury, illness or disability that prevents you from being able to continue to do your job.
- What may be tax free:
- You do not usually pay tax on the first combined £30,000 of:
- Additional severance or enhanced redundancy payments your employer gives you; and
- Non-cash benefits, for example company property you keep after your employment ends.
- You will pay tax on any amount over a combined total of £30,000.
- Your employer will pay employer Class 1A NI on any amount over a combined total of £30,000.
- You do not usually pay tax on the first combined £30,000 of:
You may be able to get part of your termination payment tax free if you are:
- Not resident in the UK for tax purposes (a non-resident) for the whole of the tax year in which your employment terminates;
- Someone who works at sea (a ‘seafarer’); or
- A serving member of the armed forces.
Any tax and NI due on your termination payment will be taken automatically by your employer in your final payslip.
- Your employer will put any taxable parts of your termination payment through their payroll and deduct any tax or NI under Pay As You Earn (PAYE).
- If you get your termination payment after you have got your P45, your employer will use an ‘0T’ tax code.
- Tax will be deducted on the assumption that you have used up your personal allowance for the current tax year.
- If your termination payment means your total income for the year is higher than in the previous year, you may pay more tax than usual.
- You can see an estimate of how much tax you will pay over the whole year.
- If you complete a Self Assessment tax return, include your termination payment as ‘additional information’.
- If you think that you have paid too much tax or you think that your termination payment has not been taxed in the right way contact HMRC.
With regards to NSRP, the same £30,000 limit applies; however, that there are some circumstances where it does not.
- Occasionally, employers will negotiate an enhanced redundancy package, which involves additional payments, with their employees, usually through their trade union, and codify the new agreement as an alteration to the existing contract of employment.
- There have been cases where the tax authorities did not regard the resulting payment as meeting the definition of “not arising from the employment” as required by the statute which grants the tax exemption.
2.15 What if I do not Work my Full Notice Period?
- You will pay tax and NI on the part of your termination payment equivalent to what you would have earned if you were working, and this may apply to:
- Lump sum payments in lieu of notice (PILON);
- Pay you are given while on ‘gardening leave’ (where you remain on the payroll but you are asked not to work); and
- Part of any severance, enhanced redundancy or non-cash benefits you get (known as Post-Employment Notice Pay (PENP).
- If PENP applies to you, your employer will work out how much you have to pay tax and NI on.
- If the amount of PENP is more than the total of any severance, enhanced redundancy or non-cash benefits you receive, you will only pay tax on the amount you actually get.
2.16 What is Payment in Lieu of Notice (PILON)?
Instead of asking an employee to work for the business during the notice period, it is possible as an employer to dismiss the employee immediately and make a payment to them for the notice period, providing there is a provision for this in the employee’s contract.
- You get all of the basic pay you would have received during the notice period.
- You may get extras such as pension contributions or private health care insurance if they are in your contract.
- Your employer may still offer you payment in lieu of notice, even if your contract does not mention it.
- If you accept, you should receive full pay and any extras that are in your contract.
- From April 2018, all PILON became subject to income tax and employee Class 1 NICs regardless of whether there is a PILON clause in the employment contract.
Things to Consider:
- Contractual PILON payments which are subject to tax and NIC as earnings (if also paying an RTA a PENP calculation is required).
- Non-contractual PILON which are RTAs.
- In order to work out the amount liable to tax and NIC, employers need to undertake the PENP calculation (refer to EIM14000).
- The formula takes into account any PILON chargeable to income tax as earnings within section 62 ITEPA 2003 by reducing the amount of PENP by the amount of the PILON (refer to EIM13896).
- The slice of the RTA that must be treated as earnings under the legislation is:
- The entire RTA if PENP is equal to or more than the RTA.
- PENP, if it is less than the RTA but is not nil (If PENP is a negative amount, it is treated as nil).
- There are two situations when the PENP calculation is unnecessary:
- If all the lawful notice due is worked or the employee is placed on gardening leave and is paid in the normal way subject to PAYE tax and NIC.
- If there is no termination payment other than items that are taxable and liable to NIC as earnings, such as a contractual PILON, holiday pay and bonus.
- Additionally, if the termination date was on or before 05 April 2018 then the PENP rules do not apply.
- How PENP is Calculated:
- Formula ((BP x D) /P) – T.
- BP = basic pay.
- D = days in the notice period.
- D is the number of days in the post-employment notice period (broadly the unworked period of notice).
- Note that D is calculated by reference to the notice that the employer must give (by contract or law).
- This may be different from the period of notice that the employee must give.
- P = days in the pay period.
- P is the number of calendar days in the employee’s last pay period ending before the ‘trigger date’.
- EIM13898 provides the definition of ‘trigger date’.
- This is where notice of termination of employment is given or received it is the date that notice is given by either party.
- Otherwise it is the last day of employment.
- T = taxable amounts on termination other than holiday pay and bonuses.
- PENP rules apply where an employee is dismissed without notice and offered a settlement agreement at a later date (the fact that there is a gap between termination and agreeing settlement terms does not prevent the rules applying).
- If a fixed term contract ends early there is still a notice period, which runs from the date of termination to when the contract would have ended.
- When determining whether there are any unserved periods of notice, employers must use whichever is the greater of the contractual or statutory notice periods that the employer is required to give.
- Meaning varying the employee’s notice period may have no impact on the application of the rules.
- It is worth noting that there is an anti-avoidance purpose test in the rules.
- Salary sacrifice as well as basic pay needs to be included when calculating PENP.
2.17 What if I Have More Than One Job with the Same Employer?
If you are concurrently employed and one of your jobs is made redundant, you will need to consider:
- How your employer intends to assess your period of continuous service (Section 1.17); and
- Which salary will be used to calculate redundancy pay.
2.18 Am I Entitled to a Tax Rebate?
- You might be due a refund if you answer ‘yes’ to all of these questions:
- Were you dismissed or made redundant part way through the tax year? (Tax years start on 06 April and end on the following 05 April).
- Were you employed and paying tax through PAYE?
- Are you still out of work?
- How much you can get back will depend on:
- How much you earned since the tax year started; and
- How much tax you paid on those earnings and any other income.
- How you go about getting your refund will depend on:
- How long you have been unemployed;
- Whether you have claimed any taxable benefits since losing your job; and
- Whether you found another job within four weeks of losing your old one.
- Jobseekers Allowance (JSA) and Other Taxable Benefits:
- If you have claimed any taxable benefits since losing your job, the Benefit Office has to pay your refund.
- This is because the tax you are paying on your benefits affects how much you owe overall.
- Taxable benefits include JSA and Carer’s Allowance.
- You will need to send the Benefit Office parts 2 and 3 of your P45 to claim your tax refund.
- Keep part 1A for your records.
- The Benefit Office will work out your refund and pay it either after the end of the tax year or after you stop claiming taxable benefits, whichever comes first.
- If you are claiming Universal Credit (UC), this is not a taxable benefit, so once you have been unemployed for four weeks you can claim your tax refund from HMRC.
- If you get a new job within four weeks:
- If you start a new job within four weeks of finishing your old one, your new employer will pay any tax refund you are owed.
- Give your new employer parts 2 and 3 of your P45, keeping part 1A for your records.
- You should get your refund with your pay.
- If you have been unemployed for at least four weeks:
- You can claim a tax refund by filling in Form P50.
- Send this to HMRC with Parts 2 and 3 of your P45.