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Redundancy Pay and ‘PILONs’ – What is Taxable?

Redundancy Pay and ‘PILONs’ – What is Taxable?
If you leave a job you need to ensure that you pay the minimum tax on any payments from your existing employer for redundancy or in lieu of notice. This article looks at some of the tax issues of employment transitions.

Broadly, the first £30,000 of any redundancy payment may be paid tax-free. This includes any statutory amount received under the Employment Protection (Consolidation) Act 1978, which is tax-free anyway. Current rates of statutory redundancy pay are:

0.5 week’s pay for each full year of service when aged under 22;

1 week’s pay for each full year of service where you are aged between 22 and 41;

1.5 week’s pay for each full year of service when aged 41 or over.

The maximum number of years that can be taken into account is 20 years, and the maximum pay limit is currently set at £430 per week.

Example

Tom is aged 45, his weekly pay limit is £430 per week and he has completed 15 years’ full service. 

Statutory redundancy pay is calculated as follows:

1.5 weeks x 4 years full service aged 41 or above = 6 weeks
1 week x 11 years service aged between 22 and 41 = 11 weeks

Total: 17 weeks x £430 (max weekly wage) = £7,310

Many employees manage to negotiate a better redundancy package than just the statutory minimum amount. Additional amounts should normally be paid tax-free, providing:

the employee has been employed for at least two years;
payments are made to all employees on equal terms; and
payments are not excessively high in relation to levels of salaries and length of service.

If your redundancy package goes over the £30,000 limit, the excess is taxed as income under PAYE in the normal way. However, if you have to leave your job because of ill-health, disability, or injury, any pay-off can normally be paid tax-free.

PILONs

If your employment contract obliges your employer to make a payment when they don’t give you  notice (known as ‘pay in lieu of notice’, or PILON for short), HMRC treat the payment as arising under the terms of your employment contract and tax will be due on the payment under PAYE.

If your employment contract provides only for notice to be given by your employer, failure to give that notice is a breach of the contract. The payment you receive is therefore treated as compensation for that breach, rather than arising under the contract. Such termination payments are generally paid tax and NIC-free, provided that your employer’s normal practice is not to make such payments and no understanding is in place that the payment would be made.

Example

Sally earns £60,000 per annum and her employment is to be terminated. Her contract specifies a six-month notice period, with a discretionary PILON clause. Sally works out three months of her notice period. Her employer makes a payment of £45,000 at the end of this period. The following treatment is likely to apply for tax purposes: 

£15,000 is taxed as a contractual PILON of the three months’ salary that Sally would have received if she had worked out her notice period; and 

£30,000 is treated as a termination payment and paid to Sally tax-free.

However, if Sally’s employer gives her notice and she chooses not to work it, she has to pay tax on the full payment. If a payment is made where notice has been given but not worked, the employee continues to be employed until the end of the period and the payment is taxable under the normal PAYE rules.

Practical Tip :

Check to make sure that the amount of any termination payment made to you tax-free isn’t included on the P45 that your employer gives you when you leave – if it is, you may be in for a big shock when you get your first pay packet from your next job!

Sarah Laing