The Real Cost of Redundancy & Managing the Tax Implications

No employer wants to lose employees but the contraction in the oil price means that this has become an unfortunate necessity for many businesses.

When staff are being made redundant it will be a difficult time all round means the tension surrounding the situation often means that the tax implications take a back seat. This can be an expensive mistake when, through lack of foresight, employers end up having to pay their employees’ tax liabilities, as well as national insurance contributions (NICs) for both parties. With HR and payroll teams working at full tilt, there’s room for error if some of the rules pertaining to tax aren’t taken into consideration. Let’s look at some of these.

The £30,000 exemption & what it really means

It is widely believed that the first £30,000 of any redundancy payment is tax-free. However, this is a somewhat simplistic view as when it comes to redundancy payments, all payments are not equal.

The £30,000 exemption only applies to payments made on redundancy that are not payments of earnings. Therefore, in deciding whether an element of the redundancy package is covered by the £30,000 exemption, (and thus free from tax and NIC) the first step is to consider whether that payment is a payment of earnings.

Payments of earnings are generally those payments that are normally made as part of the employment and under the terms of the employment contract, such as outstanding salary, bonuses, holiday pay etc.

Importantly, contractual payments in lieu of notice and also payments which it is customary for the company to make and which the employee expects to receive are also treated as payments of earnings. Payments that are deemed to be earnings remain payments of earnings even when made on redundancy, and as such are taxable and NICable in full.

Genuine redundancy payments, whether statutory or non-statutory, are regarded as compensation payments where their purpose is to compensate the employee for the loss of their job and they do not fall under the payment of earnings banner. This is good news as it means that a legitimate compensatory payment can be made tax-free up to the £30,000 limit.

& don’t forget…

Redundancy payments qualifying for exemption are only tax-free to the extent that the limit has not been exceeded. When qualifying payments exceed £30,000, the excess is taxable but not NICable.

Some redundancy payments can fall completely outside the tax regime

Certain payments made on redundancy can fall completely outside the tax regime and are therefore not taken into account in amounts to which the £30,000 exemption is applied.

For example, if an employee has worked fully overseas throughout their period of employment and was both non-resident and non-ordinarily resident in the UK then any payment would be outside the scope of UK tax. If they have worked both overseas and in the UK for the employer then a partial exemption to UK tax and NI may apply.

Furthermore, if, as part of the redundancy package, the employer agrees to make a contribution to a tax exempt pension scheme or an approved pension scheme the payment will not be subject to tax as long as the payment is not a right granted under the employment contract.

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