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Normally the process for leaving employment is quick and straightforward but this is not always the case, especially for senior or key personnel.
When there is a payment issued upon leaving, or there are residual issues to clarify regarding tax or shares, you may have some questions.
It is always highly advisable to obtain personalised advice from a professional, but below we have provided some more general guidance which may be a useful starting point.
Why Is It Important To Structure Your Settlement?
When you receive a settlement payment from your employer, it is essential that the structure is clear to all and professionally set up from a tax perspective. HMRC frequently check settlement payments and if they have not been structured correctly you could lose tax relief.
There are different ways a leaving settlement can be structured so you need to ensure the most tax-efficient option is chosen.
Specifically, the structure of the payment should make it clear whether disposing of shares is an income or capital payment. If it is the former it will be subject to tax and National Insurance under PAYE (other than those which are tax exempt). If it is the latter, it may be subject to capital gains tax if you have exceeded your annual allowance.
If the structure does not make the basis of the payment clear, HMRC may judge it as being liable for the full deduction of income tax and NI. Both the employer and the recipient can be pursued for the payment and HMRC have done this in certain circumstances.
What is the £30,000 Exemption?
There is a widespread belief that if your payment is less than £30,000 it will not be subject to tax of any kind but this is not always the case. There is a £30,000 tax-free clause but it will not apply to every type of payment.
If the payment made is regular salary or holiday pay, then it must be subject to the normal deductions. The employer must also consider whether the payment is outside the Post Employment Notice Pay (PENP).
The very rough gist of this is that PENP covers what the employee would have earned if they had worked their full notice period. You can read more about how the government defines PENP here.
Any money paid which is in excess of PENP but less than £30,000 will not be subject to tax or National Insurance. Only amounts which exceed £30,000 will be taxable.
There are other types of payment which may fall in or outside the £30,000 exemption. Statutory redundancy pay is covered by the £30,000 clause and only surplus amounts will be taxed. However, if your employer is paying you extra money on termination because of your past working record, this is a grey area and usually treated as a bonus, rather than compensation or redundancy payments and full tax/NI will apply.
Compensation due to discriminatory acts or physical injury can be paid tax-free up to £30,000.
How Are Shares Dealt With When Leaving an Employer?
Shares are taxed differently than regular earned income, including payments in lieu of notice (PILON). It is therefore important that you are clear what to do with any shares you have and what the taxable position is.
Payments to purchase or cancel shares are treated differently to a settlement agreement, and are subject to a lower rate of tax. As a capital payment they are subject to capital gains tax and mixing this money with the rest of a settlement agreement may result in you becoming liable for income tax and NI on the sum.
The shareholders’ agreement or articles of association should stipulate what action must be taken with the shares when a person leaves the company. It is not uncommon for there to be a clause which enforces the sale of shares upon departure.
You may need to seek independent advice to ascertain a fair value for your shares and subsequent payment. This is particularly the case in private companies where the subject of valuation is less clear.
Payment of Tax
The tax treatment of income tax/NI and capital gains tax is very different which is another reason why the structure of the settlement needs to be explicit.
For payments which are subject to income tax and NI, deductions will be made at source. This means the payment you receive will always be net of tax. There may also be a tax agreement included in the terns of a settlement. This obliges the recipient to reimburse the employer for any further sums of tax or National Insurance that HMRC calculate as due.
HMRC do not require capital gains tax (CGT) to be deducted at source so you will be responsible for ensuring the correct sum is declared by the deadline. The rules for payment of CGT follow the same timescales as that for other types of self-assessment: payment is due by 31st January following the tax year in which the gains were made. For example, if your gain arose in October 2020, you would not be liable to pay the CGT until 31 January 2022.
The usual CGT rules apply to these types of capital payments. This means you can transfer shares to a civil partner or spouse in order to reduce CGT liability. You can not also make use of any unused portion of your CGT allowance in previous years.
How Are Pension Payments Treated?
One alternative option is for the payment to be made directly into your pension. This will not erode any of the £30,000 allowance as pension payments are already tax-deductible.
However, it is not possible to make unlimited payments into a pension fund as a means of avoiding tax. The Annual Allowance currently £40,000 and Lifetime Allowance currently £1,073,100 for pensions must be taken into account when assessing how much can be transferred without breaking the scheme rules.
In a similar way to CGT, it may be possible to utilise some of the previous unused Pension Annual Allowance to increase the payment made into the pension.
If the money is not immediately required, paying into a pension can be a very tax-efficient means of being paid. As always, getting professional advice is strongly suggested before agreeing to the structure of a payment.