Robin Davis is a Consultant at Bray & Krais Solicitors
- From 6th April 2011 the PAYE treatment of post termination payments has changed.
- Before 6th April 2011, if a termination payment was made after the termination date and the issue of the P45 and is taxable (that is, it does not fall within the £30,000 exemption), then the employer had to use the BR tax code for PAYE purposes.
- This means that the employer only had to deduct tax at the basic rate (currently 20%). The employee had to declare the amount of the termination payment in his tax return for the relevant tax year, and pay any further tax due. While this did not change the actual amount of tax due, it had obvious cash flow advantages for employees who paid tax at the higher (40%) or additional (50%) rate.
- From 6th April 2011 employers must use the 0T tax code, rather than BR, for all post termination payments not included in a P45. The overall amount of tax will remain unaffected but higher or additional rate taxpayers will find that a much greater amount of the tax due will be deducted from their termination payments than was previously the case.
Implications
- Employers will no longer be able to offer a cash-flow advantage when negotiating a compromise agreement.
- Employers should ensure that their payroll operators are aware of this change, so that they can operate the 0T code if necessary. They should also ensure that their HR function is aware of the change so they don't automatically delay payment until after the issue of the P45. They may also need to communicate the change to ex-employees who may have been informed that post-P45 payments would be subject to basic rate tax withholding.
- The employee may suffer a number of disadvantages if the termination payment is made now and the P45 has already been issued:
- The employer will have to operate PAYE on the basis that none of the personal allowance is available (while this is the current position in the BR basis, it is currently mitigated by the cash-flow advantage of a 20% deduction rate).
- Monthly means tax, rather than calendar, months. Tax months run from the 6th of one calendar month through to the 5th of the next (as each tax year starts on 6 April). This means that payments made on, say, the 7th of one calendar month and the 2nd of the next would fall within the same tax month with the effect that only one month's bands would be available to share between the two payments.
- The change increases the risk that the amount of PAYE deducted is more than the actual income tax liability. If the employee has little other taxable income in the tax year, he could have too much PAYE deducted from the termination payment and have to reclaim some tax through his tax return.
