View the related Tax Guidance about Termination payments
Termination payments ― overview
Termination payments ― overviewTermination payments are payments compensating an individual for the loss of their job. They can take the form of cash or benefits in kind. Termination payments will either be fully taxable, partially taxable, or fully exempt depending on the nature and the amount of the payment.Depending on the circumstances, termination payments can be treated for tax purposes as:•earnings•benefits in kind•restrictive covenants•benefits from an employer-financed retirement benefits scheme (EFRBS)•termination payments (as within ITEPA 2003, ss 401–416)The taxation of termination payments is discussed in more detail in the How could a termination payment be taxed? guidance note. You are recommended to read that guidance note before continuing. For the purposes of this guidance note, it is assumed that ITEPA 2003, s 401 applies.It is the employer’s responsibility to correctly tax the termination payment and therefore the employer bears the risk of tax and penalties if the treatment is wrong. This is an area where HMRC sees frequent mistakes in the tax treatment and it has targeted such payments in the past.Termination paymentsThe provisions in ITEPA 2003, s 401 apply to cash payments and benefits in kind received in connection with the:•termination of an individual’s employment•change in duties of an individual’s employment, or•change in the earnings from a person’s employmentITEPA 2003, s 401(1)This guidance note deals with payments received on termination of employment.The payment does not need to be received by the employee / former employee. Any payments or benefits from
How could a termination payment be taxed?
How could a termination payment be taxed?Termination payments are defined in the Termination payments ― overview guidance note.Termination payments can take the form of cash, benefits or both. The payment will either be fully taxable, partially taxable or fully exempt depending on the nature and the amount of the payment.Depending on the circumstances, termination payments can be categorised as one of the following, each with their own tax and NIC treatment:•earnings ― see the Taxation of cash employment termination payments guidance note•benefits in kind ― see the Taxation of non-cash employment termination payments guidance note•restrictive covenants ― see the Taxation of payments for restrictive covenants guidance note•benefits from an employer-financed retirement benefits scheme (EFRBS) ― see the Employer-financed retirement benefit schemes (EFRBS) ― overview guidance note•termination payments (this includes benefits) within ITEPA 2003, s 401 ― see the Termination payments ― overview guidance noteIt is the employer’s responsibility to correctly operate PAYE for termination payments and they, therefore, bear the risk of potential unpaid tax and NIC as well as interest and penalties if the treatment is wrong. As this is a high-risk area, HMRC will prioritise this in compliance work. HMRC guidance on termination payments starts at EIM12800. See also Simon’s Taxes E4.8.See the Termination of employment guidance note, and other notes in the ‘Dismissal’ sub-topic, for a refresher of the essential employment law on dismissal.Analysing a termination paymentBefore deciding how to treat the termination payment for tax purposes, the total payment must
Allowable deductions for employee-related expenses
Allowable deductions for employee-related expensesThis guidance note covers the tax treatment of some common types of trading expenditure relating to employees. Some of these are disallowable under general principles, for example the wholly and exclusively test or capital versus revenue expenditure. Some are disallowed under specific statutory rules. For guidance on these, see the Adjustment of profits ― overview guidance note. In this guidance note, unless otherwise stated, references to ITTOIA 2005 are relevant for sole traders / partners and references to CTA 2009 are relevant for companies.Salaries and wagesThe costs of employing staff is typically allowable provided it meets the criteria of being ‘wholly and exclusively’ for the purposes of the trade. This includes wages or salary, plus any benefits in kind. Where remuneration is excessive, it is possible that a deduction may be challenged on the basis of not being for the purposes of the trade. This will normally only be applicable to remuneration of individuals who are connected to the business in some way.When considering the level of remuneration, the whole package of remuneration, comprising salary, wages, benefits in kind, pension contributions and other perquisites must be considered. This does not include dividends received.It is rare for remuneration to be disallowed on the grounds that it is capital. However, it might apply where employees have devoted significant time to the creation or acquisition of capital assets. This is most likely to relate to situations where construction workers perform work on their own premises or legal advisers
Taxation of non-cash employment termination payments
Taxation of non-cash employment termination paymentsTermination packages often include both cash and non-cash payments. See the Taxation of cash employment termination payments guidance note for information on the taxation of cash payments.Subject to reliefs and exemptions, non-cash benefits provided on or after termination are taxed under ITEPA 2003, s 401. Any taxable benefits arising before termination are taxed under the benefits code. It is common for non-cash benefits provided to employees during employment to continue beyond the date of termination. Benefits that straddle the termination are apportioned on a time basis, those falling after termination being taxed under ITEPA 2003, s 401 and those before taxed under the benefits code.Non-cash benefits are valued on the cash equivalent of the benefit.The cash equivalent is the greater of:•the amount that would be chargeable under ITEPA 2003, s 62 if the benefit were earnings. The amount is based on ‘money’s worth’ and will be its direct monetary value or the value it is capable of being turned into ― the second-hand value.•the cash equivalent as defined through the benefits codeITEPA 2003, s 415(2)HMRC provide examples of the calculation at EIM13905 and EIM13906.A comparison of the two values can be relevant when assets are transferred to the terminating employee as these will have ‘money’s worth’ under ITEPA 2003, s 62. The rules for transferred assets in the benefits code are set out in ITEPA 2003, ss 201–215 (the residual liability to charge). These rules cover a number of different situations depending
Termination payments ― overview
Termination payments ― overviewTermination payments are payments made to an individual relating to the loss of their job. They can take the form of cash, benefits or both. Termination payments will either be fully taxable, partially taxable or fully exempt depending on the nature and the amount of the payment. Although widely referred to as termination payments, this also applies to payments in relation to a change in the duties of employment or a change in the earnings of that employment. This note therefore covers payments related to retirement, redundancy, dismissal, death, resignation, the nature of the role being changed or a change in pay for the employment. A termination payment may also be referred to as a ‘golden handshake’.Depending on the circumstances, termination payments can be categorised as one of the following, each with their own tax and NIC treatment:•earnings ― see the Taxation of cash employment termination payments guidance note•benefits ― see the Taxation of non-cash employment termination payments guidance note•restrictive covenants ― see the Taxation of payments for restrictive covenants guidance note•benefits from an employer-financed retirement benefits scheme (EFRBS) ― see the Employer-financed retirement benefit schemes (EFRBS) ― overview guidance note•termination payments (this includes benefits) within ITEPA 2003, s 401The PAYE treatment of the various payments made on termination is discussed in more detail in the How could a termination payment be taxed? guidance note. It is the employer’s responsibility to correctly operate PAYE for termination payments and they, therefore, bear
Statutory redundancy pay
Statutory redundancy payRedundancy payments fall into two categories: statutory payments and non-statutory payments.Statutory redundancy is the amount which must be paid by the employer to the employee under employment law and is a fixed amount for each year of service. Statutory redundancy pay is usually exempt from tax (see below).Non-statutory redundancy payments are any other payment made by the employer to the employee on redundancy. The tax treatment of these payments is discussed in the How could a termination payment be taxed? guidance note.Employment law obligationsAn employee is entitled to a statutory redundancy payment if they are made redundant after being continuously employed by the employer for at least two years. The statutory redundancy payment is calculated by reference to the employee’s age, length of service and gross weekly pay. The amount of a week’s pay is subject to a statutory maximum cap which is reviewed each year. For payments made between 6 April 2024 and 5 April 2025, the maximum amount of a week’s pay is £700. Length of service is capped at 20 years. You can calculate the amount the employee must receive using the redundancy pay calculator on the GOV.UK website. The employer must provide the employee
UK employment with non-UK workdays
UK employment with non-UK workdaysIn the UK, income that a person receives as the holder of an office or employment is charged to tax as employment income. Employment income is defined in ITEPA 2003, s 7 as either ‘general earnings’ or ‘specific employment income’. Special rules apply to the taxation of general earnings of individuals who are ‘not resident’ or ‘not domiciled’ in the UK. These special rules do not apply to specific employment income. For more detailed information on types of employment income, see the Tax on cash earnings ― overview guidance note.Holding an office or employment is not sufficient to establish that an individual will be subject to tax on worldwide income. The residence status of the individual, the location of the duties, the residence status of the employer and the domicile of the individual may all be relevant in determining the extent of UK taxation. Where the employee is resident and domiciled in the UK, all general earnings are taxable when received. However, where non-residence or non-domicile is involved, the following situations arise:•some earnings are taxed when received•some earnings are taxable only when received in or remitted to the UK•some earnings are not taxable at allITEPA 2003, ss 14–41ZA (Pt 2, Ch 4, Ch 5) set out how to determine the amount of general earnings from an employment that are taxable earnings.Taxation of UK employmentAn employee who is resident in the UK is taxed on their general earnings for the tax year under
PAYE healthcheck ― outcomes
PAYE healthcheck ― outcomesOnce the PAYE healthcheck has been carried out, the organisation will receive a report. This will detail the reviews undertaken, their findings, and make recommendations to improve the employer’s compliance processes. In many cases a written report will simply be a formal record of earlier presentations made to the employer on the issued identified.As a result of the outcome of the review, changes may need to be made within the organisation.As the healthcheck report is potentially disclosable (see below), if such changes are not made and the same issues come to light in a later HMRC compliance check, this will almost certainly lead to a greater level of penalties being imposed than if the shortcomings were only discovered at that later stage.The report / feedback formatAt the conclusion of the healthcheck, a report will be provided to the employer. The format of the report should be agreed before the start of the review and ideally detailed in the engagement terms.Note that, once the employer receives a written report, it is a legally discoverable document in that it is not covered by legal privilege. In the case of R (on the application of Prudential plc and another) v Special Commissioner of Income Tax and another, the Court of Appeal ruled that advice about tax law taken from specialist tax accountants does not attract legal advice privilege. HMRC can therefore request to see the document. The report may take the form of:•a full written report on all
Foreign employment
Foreign employmentIntroductionLiability to UK tax depends on two key factors: residence and domicile. Residence refers to the individual’s tax status on a year by year basis. Domicile is the place which a person regards as their true home. See the Residence ― overview and Domicile guidance notes. Note that it is possible for a non-domiciled person to be deemed to be UK domiciled if certain conditions are met. For details, see the Deemed domicile for income tax and capital gains tax (2017/18 onwards) guidance note.An employee who works overseas may be entitled to extra reliefs and exemptions from UK tax. This guidance note covers:•reliefs for travel and subsistence when travelling overseas•exemptions for termination payments made to individuals who have worked overseas for part or all of their employment•special rules that may apply to UK resident, but non-domiciled, employees•special rules for employees in the first three years of residence (known as overseas workday relief)It does not cover the position where an individual leaves the UK to work overseas. This is dealt with in the Residence ― issues on leaving the UK (2013/14 onwards) and Reporting requirements on leaving the UK guidance notes. In addition, the Leaving the UK ― UK source income, Temporary non-residence and UK capital gains tax liability of temporary non-residents guidance notes may be useful.Remember, for tax purposes, the UK territories of the Isle of Man, Jersey and Guernsey are classed as overseas.For further discussion of the meaning of 'foreign earnings', see Simon's
Payments in lieu of notice
Payments in lieu of noticePayments in lieu of notice are known as PILONs. In essence, a PILON is a payment made to an employee when proper notice of termination is not given. The PILON is paid to compensate for the wages and benefits not received during what should have been the notice period.What payments are PILONs?In the House of Lords case of Delaney v Staples, Lord Browne-Wilkinson helpfully summarised payments that may be classed as PILONs into four categories. This case was not a tax case but is very useful in understanding the different types of payments that can be made. The categories are discussed below:•an employer gives proper notice of termination to an employee, but does not require the employee to attend work up to the termination date and pays them the wages attributable to the notice period. This situation is commonly called ‘Garden Leave’, see the Garden leave and the right to work guidance note. There is no breach of contract by the employer. The employment continues until the expiry of the notice. If the payment is made as a lump sum payment in advance; this is simply advance payment of wages. The wages are subject to tax and NIC as earnings as usual•the contract of employment provides expressly that the employment may be terminated either by notice or on the making of a PILON (ie it contains a contractual PILON). In such a case, if the employer dismisses the employee, it is not in
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