Could changes to redundancy payments cost struggling businesses money?

Having been through a period of consultation with businesses, governing bodies and tax professionals, the Government is currently considering simplifying the tax and National Insurance rules as they apply to severance payments.

The moves, if they come into force, are likely to be welcomed by the majority of businesses and employees alike, as current arrangements are often seen as complicated and confusing. Businesses are being urged to keep their eyes on developments however, as changes could lead to businesses having to pay more to workers subject to redundancies and settlement agreements.

Under the current system a lump sum payment typically has to be split into different elements for the purposes of working out tax and national insurance owed. Contractual termination payments, such as those in lieu of untaken holiday attract both tax and NIC. Non-contractual payments such as statutory redundancy pay and ex gratia payments are usually exempt from tax up to £30,000 and even above that threshold only income tax applies, with no NIC being paid on non-contractual sums.

This can cause problems for employers, who often struggle working out what parts of a payment are contractual and which are non-contractual.

The new proposals would do away with this distinction, using simple bands instead to work out the exemption threshold and any tax and NICs owed. This will certainly simplify the process for employers but it is also likely to see individuals paying more tax. The employer may therefore have to make a higher payment in order for the outgoing employee to receive the same net amount.

While this should not be an issue in the majority of cases, it does mean that firms will need to keep a closer eye on their cash flow to avoid being affected by any expenditure relating to redundancy cases. Companies should seek financial advice from insolvency practitioners in the UK if they are unsure of where they stand, as they can clarify a situation.

This is because the tax-free maximum looks likely to be lowered from £30,000 to £20,000. Up to that £20,000 limit there will be a stepped or graduated scale of relief that will be based on the length of employment. It’s possible that there may be no exemption at all for those with less than 2 years’ of continuous employment.

By Phil Smith

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