What Is Employee Termination Payment In The UK?

In general, an individual becomes a part of an organisation in the hope that they will become a worthwhile addition to the company and see an upward trajectory in their employment. However, as they say, the best-laid plans of mice and men often go awry. In the UK, employment contracts do not always end on a standard, amicable note. Sometimes, an employee may leave their job due to redundancy, early retirement, or mutual agreement. Consequently, this often leads one to know what is employee termination payment.

Principally, these payments are in place to offer financial compensation to employees when their job ends, particularly when their departure is out of the blue or outside the employee’s control. Moreover, while there are many reasons for an employee’s termination, employers must stay cognisant of the different obligations pertaining to employee termination payments, which are in contrast to their normal income payments.

Hence, whether you are an employer looking to correctly handle termination payments or an employee keen to understand your entitlements, this blog aims to elaborate on what is employee termination payment, including how they are taxed and what legal obligations apply to them.

 

 

What Is Employee Termination Payment?

An employee termination payment (ETP) is a sum of money employers give to employees when they leave their jobs or upon the termination of their employment. Primarily, termination payments are aimed at compensating an individual for the loss of their employment. Often referred to as the final pay, termination payment can comprise a lump sum or several lump sums, depending on what they are entitled to receive. Furthermore, they can also be in the form of cash or benefits-in-kind (BIKs).

If you are wondering what benefits-in-kind are and how they are taxed, you can skim through our following guides to wrap your head around it:

• Payroll benefits in kind​: Everything you need to know.
• A guide to how to calculate tax on benefits in kind.

What Does An Employee Termination Payment Include?

It is noteworthy that termination payments are typically made up of the following elements:

• Redundancy pay;
• Unused sick days payment:
• Death benefits are given to another individual upon the death of an employee.
• Ex gratia payments, which are not contractually required;
• Early retirement;
• Settlement agreements;
• Payment in lieu of notice (PILON )instead of working the notice period.
• Gratuity payment is also known as a golden handshake.
• Compensation for loss of job;
• Compensation for restrictive covenants or damages;
• Bonus;
• Accrued holiday payments.

Understanding The Taxation Of Employee Termination Payment

Taxation is an essential aspect you must take into account when figuring out what is employee termination payment.

According to HMRC guidelines, what you pay tax and NIC on is determined by what is included in your termination payment. To clarify, some parts of your termination payment might be classed as earnings. Consequently, you will be liable to pay income tax and National Insurance on them. More specifically, your earnings include:

• Unpaid wages
• Holiday pay
• Bonuses
• Payments you receive from your employer for agreeing to enter into a restrictive covenant
• Payment in lieu of notice (PILON )instead of working the notice period.

In brief, we can state that the termination payments can either be fully taxable, partly taxable, or entirely tax-exempt based on the form and the amount of the payment an employee receives. Further elaborating, the tax rates on some payments might be lower than on normal payments. As a result, only certain payments can be eligible for tax relief. Lastly, the employer must also determine the reason for paying each element separately, since each can have different tax and NIC requirements.

Further down the line, it is crucial for employees to remain mindful of their tax obligations while being a part of an organisation. Also, they must know how their income tax and NIC payments are deducted. In this respect, if you are keen on knowing more about your tax liabilities, read our following comprehensive guides:

• What is PAYE and why is it important?
• How to calculate pay as you earn tax​ (PAYE)?

What Are The Types Of Termination Payments?

When learning what is employee termination payment, it is also vital to consider its types. Although we have already discussed the taxation of termination payments, dividing them into taxable and nontaxable will give you further clarity. Under HMRC guidelines, termination payments fall into two main categories based on their tax treatment:

Contractual Payments (Taxable)

Contractual payments are agreed upon in the employee’s contract and are considered their earnings. For instance,

• Payment in Lieu of Notice (PILON)
• Accrued but unused holiday pay
• Bonuses or commissions due

Notably, these payments are fully subject to Income Tax and National Insurance Contributions (NICs).

Non-Contractual Payments (Potentially Tax-Exempt)

These are discretionary or voluntary payments, which are typically ex gratia or compensating in nature. The most common examples are redundancy payment and non-cash benefits. More importantly,  HMRC allows up to £30,000 in qualifying non-contractual termination payments to be tax-free. On the contrary, any amount greater than £30,000 is subject to Income Tax but not employee NICs. Besides, from April 2020, it is mandatory for employers to pay employer Class 1A NIC on amounts exceeding £30,000.

To learn more about the taxation of employee termination payments, visit the government website.

 

 

Conclusion

In a nutshell, understanding what is employee termination payment is tremendously significant for both employers and employees. These payments can differ based on the circumstances under which an employee is departing from the job, and also depend on the employment contracts in place. However, understanding ETPs and their tax treatment can not always be a cakewalk, especially with ever-changing HMRC rules. More specifically, businesses need to stay compliant not only to avoid penalties but also to maintain cordial employee relations. It is where pursuing expert help makes a difference. Certified payroll accountants at Payroll Services Accountants can guide employers through the proper classification, calculation, and reporting of employee termination payments. To clarify, from ensuring PAYE compliance to correctly handling RTI submissions and NICs, our well-versed accountants help you avoid costly mistakes.

Thus, be it the management of one termination or restructuring your entire workforce, outsource your payroll to our experienced professionals and forget the stress about ensuring accuracy and compliance.

Disclaimer: The content contained in this blog is exclusively aimed at informational purposes and should be treated as such. While it has been written with thorough scrutiny at the time of writing to ensure all information is correct, no warranty for the acceptance of any error or inaccuracy is given. It is not a piece of absolute financial advice, nor is it expert legal advice. Hence, it is advised to consult a professional before acting upon any information stated herein.