Thu 03 Sep 2020

Changes to calculation of Post-Employment Notice Pay

Draft legislation aims to remove unintended unfairness created by changes made to the taxation of termination payments in 2018

The concept of Post-Employment Notice Pay ("PENP") was introduced with effect from April 2018 by the Finance Act (No 2) 2017 under the much heralded proposals to change the way termination payments were taxed.  PENP is the part of a termination payment which is treated as being payment in respect of the employee's notice period and subject to income tax and employee's and employer's NICs.  The aim of the changes made in April 2018 was to ensure that all contractual, customary and non-contractual payments in lieu of notice ("PILON") were consistently subject to income tax and NICs. Prior to that date, the tax treatment of payments made in lieu of the employee working their notice period was dependent upon whether there was a contractual PILON in the contract of employment. 

PENP is currently calculated on the basis of either the simplified formula or the general formula.  The simplified formula applies to an employee who is paid monthly, whose contractual notice period is expressed in months and whose employment is terminated with immediate effect or whose unworked period of notice is a whole number of months.  The general formula is more complex and applies where the pay period is not expressed in months or the notice period, or the unworked portion of it, is not expressed in months - to address such cases the general formula uses the number of days in the pay period ("P") as one of the inputs, and this can vary between 28 and 31 days.

This variation in the number of days in a pay period has had an unintended consequence, as less favourable outcomes occur depending on when in the year employment is terminated.  To address this the draft Finance Act 2021 will amend ITEPA 2003 to provide an alternative formula for calculating PENP where the pay period is defined in months but the notice period is not a whole number of months.  Instead of using the number of days in the pay period as P, the average number of days in a month is used, being 30.42 days.  HMRC has been able to permit use of this figure on a discretionary basis since October 2019 where this inconsistency has arisen and the alternative calculation is advantageous to the employee, but the amended legislation will mean it will apply in all such cases from 6 April 2021.

A further unintended consequence of the changes in 2018 was that tax treatment varied depending on residency.  Currently PENP is not chargeable to UK tax if an employee is non-resident for the tax year in which their employment terminates.  From April 2021, this will be rectified by way of a new measure aligning the tax treatment for those who are non-resident when their employment terminates with the treatment of all UK residents.  This is though only effective to the extent that non-residents would have worked in the UK had they been working their notice period - it therefore only affects those who physically perform their employment duties in the UK.

The new provisions will apply where employment is terminated and the termination payment is received on or after 6 April 2021.

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