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All payments in lieu of notice (PILONs) are subject to income tax and national insurance contributions (NICs) in full. The relevant rules are quite complex, as they require employers to calculate the employee’s post-employment notice pay before deducting tax and NICs. This Inbrief explains the rules and gives some practical examples.The content includes:Overview of the rulesWhat is PENP and how is it calculated?What is basic pay?Which allowances are excluded?What is the impact on an employee’s termination payment?Practical examplesWhat are the implications of the rules?Specific situations Overview of the rules If an employee’s employment terminates and the employer pays a “relevant termination award” to that employee, the employer must calculate how much of the relevant termination award is “post-employment notice pay” (“PENP”).A relevant termination award is any payment or benefit which compensates the individual for the termination of their employment, excluding any statutory redundancy pay.The PENP is subject to income tax and employee and employer NICs in full. The balance of the relevant termination award and any statutory redundancy payment is eligible for the £30,000 tax and employer NICs exemption and 100% employee NICs exemption.What is PENP and how is it calculated?PENP is, broadly, the basic salary the employee would have received during any unworked period of notice minus any contractual or deemed PILON.PENP is calculated using the following formula:((BP x D)/P) – TWhere generally:BP = “basic pay” in the pay period which ends prior to the date on which notice is given, or, if no notice is given, the termination date (“relevant pay period”).D = the number of calendar days in the “post-employment notice period” being the period beginning at the end of the date on which the employee’s employment terminates and ending on the earliest date on which the employer could lawfully terminate the employee’s employment by notice.P = the number of calendar days in the relevant pay period.T = contractual or deemed contractualFor employees who are paid monthly in 12 equal instalments, it may be possible to use a simplified formula.Where the minimum notice period under the employment contract is expressed as a number of whole months and the unworked notice period is a number of whole months, D = the number of whole months in the unworked notice period and P = 1 whole month.Where the employee’s unworked notice period is not a number of whole months, D = the number of calendar days in the unworked notice period and P = 30.42.If the formula results in a negative number, PENP is zero.To help you calculate PENP, see our PENP calculator. What is basic pay for these purposes? Basic pay excludes benefits, bonuses, commission, some allowances (see below), share options/awards. However, if the employee participates in a salary sacrifice arrangement, pre-sacrifice salary must be used – in practice many employers use pre-sacrifice salary to calculate contractual PILONs in any event.Basic pay will not necessarily be the same in every pay period. In some situations the employee may have received a one-off payment which increases their basic pay (for example, a payment for accrued holiday). In other situations the employee’s basic pay may be reduced (for example, if the employee is off sick and only receiving sick pay).Which allowances are excluded from basic pay?HMRC guidance states that an allowance is “a supplementary payment received by an employee over and above their standard pay”.HMRC give the following examples of allowances which are excluded from basic pay:Allowances paid in recognition of particular circumstances, such as an additional responsibility allowance for temporarily undertaking duties not otherwise required under the employment contract;Allowances paid in recognition of particular working arrangements, such as a weekend working allowance for an employee working unsociable hours; andAllowances paid to reimburse an employee for out of pocket expenses, such as a travel allowance to cover an employee’s transport costs whilst performing duties of the employment.However, HMRC guidance also states that any amount which has in reality, been consolidated into an employee’s standard pay must be included in basic pay.For example, if an employer ceases to provide a benefit but compensates employees by playing an allowance, that amount should be included in basic pay. This would include for example, allowances paid in lieu of pension contributions.Whether a car allowance constitutes basic pay depends on the circumstances. HMRC guidance states that generally if an employee is provided with a choice between a company car and a car allowance, it is likely that the allowance should be excluded from basic pay. In no names correspondence, however, HMRC suggested that if the employee were asked to make the choice several years ago, over time the allowance may have actually been consolidated into basic pay. Employers may want to seek specific guidance on the point.What is the impact on an employee’s termination payment?In some circumstances the PENP may be greater than the employee’s PILON and in others it may be equal to or less than the employee’s PILON.Where the PENP is greater than the employee’s PILON, this will have implications for the tax and/or NICs treatment of any relevant termination award:If the employee’s relevant termination award (and any statutory redundancy pay (“SRP”)) is less than £30,000, the amount to which the £30,000 tax exemption and NICs exemption applies is reduced.If the employee’s relevant termination award (and any SRP) is more than £30,000, the amount to which the NICs exemption applies is reduced.Where the PENP is equal to or less than employee’s PILON, the £30,000 tax exemption and NICs exemption will apply in accordance with the normal rules.Practical examplesExample 1: 6 months’ notice period; no PILON clause; no salary sacrifice; no cash allowancesOn 31 October, Jo is told that she is being made redundant. She has to leave her job immediately without working her notice. Her employment contract provides for 6 months’ notice but there is no PILON clause. Jo is paid monthly in 12 equal instalments and her monthly gross basic salary is £6,750 per month. Jo does not participate in a salary sacrifice arrangement and does not receive any cash allowances. Jo receives a termination payment of £50,000 including £4,000 statutory redundancy payment.Jo’s relevant termination award is £46,000 (£50,000 - £4,000).Jo’s PENP is £40,500 ((£6,750 x 6)/1)).This means:PENP of £40,500 is subject to tax and NICs in full.Statutory redundancy payment of £4,000 benefits from the £30,000 exemption and is not subject to tax or NICs.The balance of the relevant termination award of £5,500 benefits from the £30,000 tax and employer NICs exemption and 100% employee NICs exemptionExample 2: 3 month notice period; contractual PILON based on pre-sacrifice salary no cash allowancesIn December, Adam is told that he is being made redundant. He has to leave his job immediately without working any of his notice.His employment contract provides for a 3 month notice period and there is a PILON clause. Adam is paid monthly in 12 equal instalments and his monthly gross basic salary is £4,500 per month. Adam participates in a salary sacrifice arrangement and sacrifices £500 per month so his pre-sacrifice salary is £5,000 per month. He does not have any cash allowances. Adam receives a termination payment of £20,000 including £4,000 statutory redundancy payment and a PILON of £15,000 (based on pre-sacrifice salary).Adam’s relevant termination award is £16,000 (£20,000 - £4,000).Adam’s PENP is £0 ((£5,000 x 3)/1 - £15,000).This means:£15,000 PILON is subject to income tax and NICs in full.£4,000 statutory redundancy payment benefits from £30,000 exemption and 100% NICs exemption.The relevant termination award of £16,000 benefits from the £30,000 tax and employer NICs exemption and 100% employee NICs exemption.Example 3: 5 week notice period; contractual PILON based on pre-sacrifice salary; no cash allowancesIn December, Jim is told that he is being made redundant. He has to leave his job immediately without working any of his notice. His employment contract provides for a 5 week notice period and there is a PILON clause. Jim is paid monthly in 12 equal instalments and his monthly gross basic salary is £4,500 per month. Jim participates in a salary sacrifice arrangement and sacrifices £500 per month so his pre-sacrifice salary is £5,000 per month. He does not have any cash allowances. Jim receives a termination payment of £20,000 including £4,000 statutory redundancy payment. Jim also receives a PILON of £5,770 (£60,000/52 x 5). The relevant pay period is November which has 30 days.As (i) the relevant pay period is a month; (ii) Jim is paid in 12 equal monthly instalments; and (iii) the post-employment notice period is not a number of whole months, P =30.42. This means Jim’s PENP is zero (£5,000 x 35/30.42) - £5,770. The whole of Jim’s termination payment of £20,000 therefore benefits from the £30,000 tax and employer NICs exemption and 100% employee NICs exemption.Example 4: 2 month notice period; contractual PILON based on pre-sacrifice salary; car allowancesIn June, Amy is told that she is being made redundant. She has to leave her job immediately without working any of her notice.Her employment contract provides for a 2 month notice period and there is a PILON clause. Amy is paid monthly in 12 equal instalments and her monthly gross basic salary is £2,500 per month. Amy participates in a salary sacrifice arrangement and sacrifices £100 per month so her pre-sacrifice salary is £2,600 per month. Amy also receives a £250 car allowance per month. Amy receives a termination payment of £12,000 including £2,000 statutory redundancy payment and a PILON of £5,200.Amy’s relevant termination award is £10,000 (£12,000 - £2,000).Amy’s PENP is £500 ((£2,850 x 2)/1 - £5,200).This means:£5,200 PILON is subject to income tax and NICs in full.£500 PENP is subject to income tax and NICs in full.£2,000 statutory redundancy payment benefits from £30,000 exemption and 100% NICs exemption.The balance of the relevant termination award of £9,500 benefits from the £30,000 tax and employer NICs exemption and 100% employee NICs exemption.Example 5: 3 month notice; partly worked contractual PILON based on pre-sacrifice salary; no cash allowancesOn 1 July, Charlotte is given notice that she will be made redundant. Her employment contract has a 3 month notice period so her employment will end on 30 September. Charlotte is required to work 6 weeks of her notice until 10 August. Charlotte is paid monthly in 12 equal instalments and her monthly gross basic salary is £3,750 per month. Charlotte participates in a salary sacrifice arrangement and sacrifices £250 per month so Charlotte’s pre-sacrifice salary is £4,000 per month. Charlotte does not have any routine allowances.Charlotte receives a termination payment of £16,000 including £4,000 statutory redundancy payment and a PILON (based on pre-sacrifice salary) of £6,710 (£4,000 + (£4,000 x 21/31). The relevant pay period is June which has 30 days.As (i) the relevant pay period is a month; (ii) Charlotte is paid in 12 equal monthly instalments; and (iii) the post-employment notice period is not a number of whole months, P =30.42. This means Charlotte’s PENP is zero (£4,000 x 51/30.42) - £6,710. The whole of Charlotte’s termination payment of £16,000 therefore benefits from the £30,000 tax and employer NICs exemption and 100% employee NICs exemption.Example 6: 12 weeks’ notice; no PILON clause; salary sacrifice arrangement but PILON is calculated on pre-sacrifice salary; no cash allowancesOn 17 July Mary is told that she is being dismissed. She has to leave her job immediately without working her notice. Her employment contract has a 12 week notice period. Mary is paid weekly and her weekly gross salary is £1,300 per week. Mary participates in a salary sacrifice arrangement and sacrifices £200 per week so her pre-sacrifice salary is £1,500 per week. Mary receives a termination payment of £32,000. There is no statutory redundancy payment. The relevant pay period is June which has 30 days.Mary’s PENP is £18,000 (1,500 x 84/7). This means £18,000 is subject to income tax and NICs in full. The balance of the relevant termination award of £14,000 benefits from the £30,000 tax and employer NICs exemption and 100% employee NICs exemption.Example 7: 6 months’ notice; PILON clause; salary sacrifice; no notice period worked; no cash allowancesOn 31 October, David is told that he is being made redundant. He has to leave his employment immediately without working his notice. His employment contract provides for 6 months’ notice and there is a PILON clause calculated by reference to basic salary. David is paid monthly in 12 equal instalments and his monthly gross basic salary is £6,000 per month. David participates in a pension salary sacrifice arrangement under which he sacrifices £1,000 gross per month so his monthly pre-sacrifice salary is £7,000. David receives a termination payment of £50,000 including £5,000 statutory redundancy payment and a contractual PILON of £36,000 (based on £6,000 per month) plus £6,000 contribution into his pension.David’s relevant termination award is £45,000 (£50,000 - £5,000). The £6,000 pension contribution is ignored.David’s PENP is £6,000 ((£7,000 x 6)/1)) - £36,000.This means:PILON of £36,000 is subject to tax and NICs in full.PENP of £6,000 is subject to tax and NICs in full.Statutory redundancy payment of £5,000 benefits from the £30,000 exemption and is not subject to tax or NICs.£25,000 of the relevant termination award benefits from the £30,000 tax and employer NICs exemption and 100% employee NICs exemption.£14,000 of the remainder of the relevant termination award is subject to income tax and employer NICs but not employee NICs.What are the implications of the rules?The rules have the following implications:This means:There is no tax disadvantage in having a PILON clause for basic salary in the contract.If the employee works out their full notice or is put on garden leave for their full notice, the rules do not apply.In those situations where the rules do apply, the employer will need to ensure any settlement agreement makes clear that the employer will deduct income tax and employee NICs from PENP.Employers will need to calculate the PENP for each employee whose employment is terminating, including those employees whose contracts of employment contain a PILON clause. Employees are likely to want to see this calculation before signing any settlement agreement.If the PILON is contractual and the employee is paid in 12 equal monthly instalments, it is likely that the PILON will be zero if there are no salary sacrifice arrangements in place (or PILON is calculated on the basis of pre sacrifice salary) and no standard cash allowances are paid (or PILON is calculated taking those allowances into account). This depends on how the contractual PILON is calculated and will still need to be checked in every case.Scenario 1The PENP is likely to be zero if:There is a contractual PILON based on a number of whole months;There is no salary sacrifice arrangement in place (or PILON is calculated on the basis of pre-sacrifice salary);No standard cash allowances are paid (or PILON is calculated taking those allowances into account); andThe unworked period of notice is in a number of whole months.Scenario 2The PENP is likely to be zero if:There is a contractual PILON based on a number of weeks;There is no salary sacrifice arrangement in place (or PILON is calculated on the basis of pre-sacrifice salary); andNo standard cash allowances are paid (or PILON is calculated taking those allowances into account).Specific situationsThere are a number of situations where employers may want to seek specific advice:There are anti-avoidance provisions which allow HMRC to ignore any arrangements which are designed to reduce PENP. HMRC has confirmed that they would not seek to apply these provisions where the employee asks for some or all of the relevant termination award to be paid into their pension as an employer contribution, even if this reduces the amount which is subject to tax and NICs as PENP Often, rather than requesting that some or all of their relevant termination award is paid into pension, an employee may request that some or all of the PILON is paid into pension as an employer contribution. Whilst this is possible if a valid salary sacrifice arrangement is implemented prior to the termination of the employee’s employment, the PENP rules means that generally it will not result in any tax savings and, depending on the circumstances, it may reduce the amount which is eligible for the £30,000 tax exemption so such a request should generally be refused.Where the employee has received no pay in the period immediately before notice was given (or if no notice was given in the period immediately prior to the termination date) (because for example the employee had exhausted their entitlement to both company and statutory sick pay), it is unclear whether that period can be used for the purposes of calculating PENP. The issue is whether a period only constitutes a pay period if the employee has actually received pay in that period. HMRC has indicated in no names correspondence that in those circumstances they accept that PENP is zero (on the basis that the BP would be zero). However, employers may want to seek specific guidance from HMRC on this point.If an employee’s employment is terminated summarily without notice or pay in lieu of notice (and an employment tribunal does not subsequently overturn the dismissal), HMRC accept that the PENP is zero. The employer is not obliged to give any contractual or statutory notice and therefore there is no unworked notice period. It is important, however, that the facts are consistent with the summary dismissal and this is reflected in any settlement agreement.
