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PAYE DAY Robin Davis explains implications of change in PAYE treatment of post termination payments From April 6 2011 the PAYE treatment of post termination payments has changed. Before then, 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 per cent). 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 per cent) or additional (50 per cent) rate. From now on 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. The practical effect of the change will be that employers will no longer be able to offer a cash-flow advantage when negotiating a compromise agreement. The regulations (a copy of which is attached) state that the 0T tax code is to be applied on a "non-cumulative" basis. For an employee paid on a monthly basis, this means that only 1/12th of the basic rate band (and, if relevant, 1/12th of the higher rate (40 per cent) band) is available in the month of payment. This will mean that if the termination (or other) payment is more than the appropriate proportion of the 20 per cent band, the excess will be taxed under PAYE at 40 per cent, and if the payment is also more than the available 40per cent band, the excess will be taxed under PAYE at 50 per cent. For example, the PAYE that has to be applied to any post-P45 payment in the first month of the 2011-12 tax year (month one) will be roughly as follows:
The PAYE is calculated as follows: 2,916.67 @ 20 per cent = 583.33 7,083.33 @ 40 per cent = 2,833.33
The PAYE is calculated as follows: 2,916.67 @ 20 per cent = 583.33 9,583.33 @ 40 per cent = 3,833.33 7,500 @ 50 per cent = 3,750 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. Indeed, the employee may suffer a number of disadvantages if the termination payment is made now and the P45 has already been issued. Firstly, 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 per cent deduction rate). Secondly, "monthly" means tax, rather than calendar, months. Finally, 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. The practical impact of this change is that, from now, it will no longer be the case that a cash-flow advantage will generally arise from making payments after issuing the P45. Instead, the relative merits (from a cash-flow perspective) of pre- or post-P45 payment will need to be assessed individually in each case. Robin Davis, Consultant at Bray & Krais Solicitors. |
