New rules apply to redundancy payments made in lieu of notice (PILON) starting from the 2018/2019 tax year. Employers making a redundancy payment will be required to tax the portion of the payment that is equivalent to the basic pay that would have been earned had the employee worked through their notice period.
Current rules state that if a contract includes a provision to make a PILON, where the employee is given a monetary compensation for redundancy instead of a notice period to work, that payment would be subject to taxes as normal (both income taxes and national insurance). However, payments made where an employee contract is terminated immediately without notice, e.g. redundancy, and the payment was not part of the contract, these are tax-free up to a £30,000 limit.
Under the new rules in effect from this April, employers will need to calculate the equivalent of the post-employment notice pay - this is the basic salary the employee would have been given if they were able to work a normal notice period. The employee would then be subject to income tax and national insurance on the PENP (post-employment notice pay) portion of the termination payment as well as any of the remainder that is over the £30,000 tax exemption limit.
For example, an employee who normally earns £3,000 per month, receives a £20,000 payment on termination of their contract. They do not work a notice period, but normally have a notice period of 2 months. The payment the employee received was not written in their employment contract. If this payment was received last year, the employee would have kept the entire amount tax-free and NIC-free. This tax year forward, the employee would pay income tax and national insurance on £6,000 - this is the PENP. The employer would also pay the employers' element of national insurance on the PENP amount. The remaining £14,000 non-PENP part of the payment is below the £30,000 limit so has no further deductions.
Employees that receive a statutory redundancy payment - these are based on age, weekly pay and number of years with the employer - are still subject to the £30,000 tax exemption limit as per previous rules.
From April 2019, employers will need to pay employers' NIC on any portion of a termination payment over the £30,000 limit too.