On 21 July 2020, the UK Government published a policy paper and draft clauses for inclusion in the next Finance Bill (2020/2021) which provide an alternative post-employment notice pay (PENP) calculation in certain circumstances and make amendments to the UK tax treatment of PENP for non-UK residents.
Alternative PENP calculation
The current PENP rules can require all or a portion of any termination payment to be reclassified as general earnings (subject to both income tax and national insurance contributions) if and to the extent the employee has a period of unworked notice. This reclassification is determined in accordance with a statutory formula which looks at both the length of the employee’s last pay period and the length of their unworked notice period.
Where an employee is paid monthly but their notice period is not expressed in months, the statutory formula can, however, produce unintended outcomes. In particular, if the last pay period falls in a short month (e.g. February), this can skew the calculation and result in a higher amount of PENP than if the last pay period fell in a longer month (e.g. March).
Recognising this, HMRC set out an alternative basis of calculation in the October edition of their Employer Bulletin. This alternative gave employers the option of using 30.42 for the number of days in the last pay period where doing so would be to the advantage of the employee in circumstances where the employee was paid monthly in equal monthly instalments and their notice period was either not expressed in months or their unworked notice period was not a whole number of months.
The draft clauses put this alternative basis of calculation on a statutory footing for payments made on or after 6 April 2021 in connection with terminations that take place on or after that date. Importantly, however, they remove the requirement that using 30.42 is to the advantage of the employee and remove any optionality in applying the alternative basis of calculation. Although this change will eliminate inconsistency, and for that reason is to be welcomed, it will also mean that employers will need to take extra care when carrying out PENP calculations to ensure that they are using the correct version of the statutory formula.
The UK does not currently impose income tax on termination payments which are reclassified as general earnings under the PENP rules where the employee is non-UK tax resident in the tax year that their employment terminates. The Government considers this to be an unintended outcome of the legislation where the employee has physically performed duties in the UK and would have worked in the UK during their notice period (and therefore would have been subject to UK tax during their notice period).
The draft clauses rectify this by effectively aligning the tax treatment of PENP for individuals who are non-resident in the year of termination of their UK employment with the treatment for all UK residents. This is achieved by subjecting to UK tax the portion of any termination payment that is reclassified as general earnings under the PENP rules which can reasonably be attributable to any notice period that would have been physically served out in the UK if notice had been served.
As for the changes to the PENP calculation, the changes above will also apply to payments made on or after 6 April 2021 in connection with terminations that take place on or after that date. This again will mean that, from April 2021, employers will need to take extra care when making payments to non-UK resident employees to determine how much notice it is reasonable to assume they would have physically carried out in the UK to ensure that they calculate and process any UK tax liabilities correctly.
For further information please contact a member of the team below or your usual DLA Piper contact.