Making staff redundant is never easy. But where the employer can afford to make a payment to the employee over and above the statutory redundancy, which is capped at £350 per week, both sides may feel better about the process. These additional redundancy payments are often referred to as payments in lieu of notice (PILON).
HMRC used to argue that where the employer regularly made a PILON to departing employees this would create an implicit right for other employees to receive such a payment. The PILON thus became part of the custom and practice of the employer, and as such it was taxable. However, after HMRC lost successive arguments on this point they changed their guidance on PILONs, which is now found in their Employment Income Manual.
The new guidance emphasises that where PILONs are paid automatically they will be considered to be taxable under the custom and practice rule. However, where the PILON is considered individually for each departing employee, and the amount is critically assessed as to exactly how much should be paid, the PILON should not be considered as being paid automatically. A PILON in this case is more akin to damages for breach of contract, and thus can fall within the £30,000 tax free limit for redundancy payments.
Remember this tax free payment on the termination of an employment can only apply to payments which are not:
Contractual; or
a restrictive covenant; or
a pension.
If the payment falls outside these areas it can be tax free up to £30,000, but the whole of the termination payment will be free of national insurance.
Some of the legal hurdles to making employees and directors redundant are covered below. It is worth reviewing these points if you are thinking about making staff redundant.
Letting staff go
There are a number of legal hoops to jump through when making staff redundant, and unless you happen to be a qualified employment lawyer we recommend you take appropriate professional advice. Even if the business has made staff redundant before, it is a good idea to check the latest guidance as the law has been changed recently in this area. The key points to note are:
Redundancy consultation
If the business is to make 20 or more employees redundant over a 90 day period it must consult with the workers’ representatives at least 30 days in advance, or 90 days in advance, where there are 100 or more proposed redundancies. The business must also notify the Department for Business, Enterprise and Regulatory Reform (BERR) in writing by letter or by using form HR1.
Redundancy pay
The business can pay redundancy pay at any level it wishes, but the employee has a right to receive at least a minimum level of statutory redundancy pay. The statutory pay is based on a formula that includes the employee’s age and length of service. The BERR website includes a calculator to work out the amount of statutory redundancy pay. If the business is in liquidation and has no funds to pay the statutory redundancy, the ex-employee can apply to the BERR Redundancy Payments office for payment using the form RP1.
Re-employing people
The employee has a right to be offered alternative employment wherever possible. The employee can be trialled in an alternative job without losing their right to statutory redundancy pay. However, there must be a genuine redundancy of the original job (not the person) for any redundancy pay to be tax free.
Business link advice on making an employee redundant
Statutory redundancy calculator
BERR leaflet on employees’ rights in redundancy
Directors and redundancy payments
Every accountant has heard of the £30,000 tax free redundancy payment, and many directors think they can pay themselves this amount when they shut down their own company. However, HMRC will rarely agree to the tax free treatment for controlling shareholders. Instead HMRC will invariably put up the following challenges:
No employment contract
The director needs to have employment contract with the company to be an employee and receive tax free statutory redundancy payments. However non-statutory redundancy payments may be possible even without an employment contract.
Payment for shares
Where the company is also being sold, or is repurchasing its shares from the director, it is important to separate the payment for the director’s shares from any redundancy payment. The profits from share disposals will generally be subject to capital gains tax. If these payments have been reduced to compensate for the ‘redundancy’ payment the tax treatment will be susceptible to challenge.
Writing off loans
Where the director’s account is overdrawn a write-off of that balance is treated as earnings and cannot be part of a tax free redundancy package. It will also be subject to NICs even if treated as a distribution for income tax purposes.
Unapproved retirement payment
HMRC feel that any employee aged over 55 who receives a large sum on ceasing employment must be retiring, so the payment is a pension and hence taxable. It is up to the company to prove the redundancy is genuine.
There are many other arguments HMRC can throw up to catch the payment to the departing director in the tax net.
The other side of the coin is the corporation tax position. Can a deduction (whether more than, less than or exactly £30,000) be legitimately claimed for a redundancy payment made to a controlling Director? Only if it satisfy the test as being incurred for the purposes of the trade or to ensure the orderly winding down of the business. These are tough tests to satisfy when the company is failing or is being sold.
If you as a Director want to pay yourself more than the statutory minimum redundancy, which is capped at £9,900, take appropriate professional advice or alternatively ask one of our (the tax advice network) tax experts for advice first so as to maximise the prospect of securing tax deductibility and avoiding a tax liability on the receipt. But beware – it’s not easy!
HMRC guidance on termination payments
Article by guest blogger: Mark Lee from The Tax Advice Network.
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