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Understanding Employee Termination Payments

Managing the end of the employee lifecycle has always had an element of complexity. The Finance (No 2) Act 2017 incorporates new and updated sections to the Income Tax (Earnings and Pensions) Act 2003 (ITEPA).

Specifically there are new ways to go about termination payments, including new formula to be used for tax. These come in to effect on 6th April.

To help you get to grips with employee termination payments, we’ve put together a short guide that will help you understand just what you need to do when it’s time for an employee to leave.

6 April 2018 – the cut-off date

From 6 April some new rules come in to effect. From this point, the total amount of an employee termination payment will be subdivided in to two parts.

The first part covers the notice period and is subject to both tax and NICs. The second (or everything else) is taxable subject to a £30,000 exemption.

In terms of understanding this as an employer you need to be aware of a few things.

Firstly, you need to know and understand the formula for Post-Employment Notice Pay (PENP). Secondly you need to understand the new definitions which are coming in to force. Thirdly, you need to be clear about how this affects your business and how you work out termination packages.

The formula

The PENP formula works firstly at establishing the pay for any notice period not worked. It is made up of the last day worked to the last day of the minimum notice period.

The formula below shows Basic Pay (BP) within the last pay period and is divided by the length of the last pay period (P). This is multiplied by the length of the PENP (D – duration). This makes up the first part of the formula:






After this calculation it is necessary to deduct any applicable taxable termination payment (T). This may include payment in lieu of notice irrespective of whether it is contractual. The result is that the complete formula is:





Hopefully this is a simple explanation but a few words of warning: you need to be clear about the definitions.

The definitions

Basic Pay (BP): This is defined as ‘employment income of the employee from the employmenT’ and includes:

  • Overtime, commission, bonuses, allowances and gratuities
  • Any amount received by the employee in connection with the employment termination
  • Sums taxable as expenses and benefits
  • Employment income comprised of securities and options
  • Sums forfeited by the employee but which would otherwise have been considered earnings

It’s worth noting, therefore, that you mustn’t just assume the BP from the previous complete pay period. Take care to calculate it.

Total Termination Payments (T): This is defined as ‘the total amount of any payment or benefit received in connection with the termination’. It must be taxable as earnings but not pay for any leave entitlement which is taken before the end of employment, neither any bonus payment at the termination of employment.

Trigger date: This is the last date of employment if no notice has been either given or received, or, more commonly, the day that notice was given. This is not the same as the effective date of termination which is most usually the last day working for the business. The trigger date is always fixed.

Post-employment notice period: This applies to the duration of time from the day after employment ended until the last day of the minimum notice period. This applies whether this is statutory or contractual. This is important should an employee be asked to leave without working their notice.

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