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WHT Rate Change Impacts Employee Termination Payments

17 Mar 2011

For as long as most people can remember where an employee or director in the UK has had their employment terminated, the usual tax withholding after leaving employment on any payment over ?30,000 has been at the basic rate (currently 20%).

The individual must report the payment to Her Majesty's Revenue and Customs (HMRC) by the 31 January following the end of the UK tax year (5 April) and pay the remaining tax due, usually at 40% less the 20% already paid, again by 31 January.

HMRC with very little publicity are changing the deduction which must be made to the employee's highest rate of tax for the month, in most cases this will be now be 40% or 50%.

This will impact all employers in the UK who must implement the new rates or suffer recovery of the tax due, penalties and interest. Terminated employees lose the tax cash flow advantages of their lump sum. Employees who subsequently do not owe tax at 40% or 50% will have to seek a refund from HMRC.

HMRC are also changing the tax due for new employees who do not have a form P45 from their previous employer when joining a new employer. Rather than tax at Basic rate (20%) deductions will be due at higher rates depending on the level of income. Taxand UK investigates the latest withholding tax rate change on employee termination payments and certain new employees and what taxpayers in these situations should look out for. This has been given little publicity and will not have been seen by many employers although It has started to be picked up by the financial press and media in the last few weeks. HMRC say the new rules will be set out in their guidance booklet CWG2 (2011) published at the end of February.

The current practice where a payment is made after leaving and a form P45 has been issued is long established and is well known and complied with. It potentially affects every employer in the UK and so a great many are likely to be unaware of the change when the new rules become effective from 6 April 2011.

This is likely to have been implemented to increase the tax flow into the Treasury. Currently some employees have tax at 20% deducted from their termination payment and do not pay the additional 20% or 30% tax until up to 21 months later. This for some is a very useful cash flow advantage. For others it is a disaster as they do not put aside the tax they will need to pay and consequently do not have the money when payment is due. Some invest the money but make a bad investment and consequently no longer have the full tax liability due.

Under the new rules there will be a significant number of individuals who will be over taxed at the time of termination. They will be due a significant refund but could have to wait in excess of 21 months for this thus giving the UK Treasury an interest free loan. This arises because payments will be taxed on what is known as a month one basis. Consequently, an individual could pay 50% tax on a taxable termination payment as low as ?12,500.

The concern is therefore that modestly paid individuals with substantial service in an employment could receive a termination payment which for the month of payment projects them into 50% tax but who receive very little other income in the tax year and are consequently due a sizeable tax refund. Often the money is essential for them to live on but may not be refunded for a considerable length of time.

HMRC in the same weekly update also announced that where an employee does not produce a form P45 from their previous employer and a form P46 needs to be signed, tax will no longer be deductable at just basic rate (BR), instead tax will be deducted using a code OT which means no allowance and tax will be payable depending on income at a rate up to 50%.

This again is another cash flow measure but does make commercial sense as higher earners will pay close to the correct amount of tax in the first month working for a new employer rather than being significantly under taxed and having a larger tax bill in month 2 when the correct tax code has been issued.

Taxand's Take

Ensure that all those in Payroll, HR, tax and finance together with business unit leaders are aware of this significant change to tax on termination payments. It is essential the correct deductions are made at the time of payment and also that any revisions to employee hand books, policies, employee communications are made. Failure to take action will lead to employers owing tax, penalties and interest. Employees will over pay rather than underpay but must be warned of this fact. Those most likely to be due a refund of tax may benefit by being advised of this likelihood and told of the steps they can take to ensure the earliest possible refund.

Payroll staff and HR should be aware of the new tax deductions for starters who sign a form P46.The employees affected should pay close to the correct amount of tax and so employers are less likely to have queries from these employees once the correct code has been issued by HMRC.

Your Taxand contact for further queries is:
Colin Keane
T. +44 207 072 3266

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Taxand's Take Author