PAYE treatment post 6th April 2011

Changes to PAYE treatment of post-P45 payments

Businesses dealing with various types of post-termination payments (for example, payments under compromise agreements) need to be aware of changes to the PAYE treatment of post-P45 payments.

From 6 April 2011, if your business makes a payment to an ex-employee after the P45 has been issued, and the payment is subject to PAYE, you must generally deduct tax using a new 0T code, which:

• Does not allow for any personal allowance.
• Means that income tax is withheld at the basic (20%), the higher (40%) and additional (50%) rates of tax, depending on the size of the payment, applying the monthly equivalents of the annual limits on the basic and higher rate bands (or the weekly equivalents, if the employee was subject to PAYE on a weekly basis).
• Will apply on a non-cumulative basis, so if there are several post-P45 payments in different tax weeks or months, all of them will be subject to PAYE, as if made in the first tax week or month of the year, and without reference to the previous payments.

However, if post-P45 PAYE is due on shares or options received under an employee share scheme (or in respect of any other employment-related securities tax charge), this will continue to be calculated using the BR PAYE Code and income tax will be withheld at 20% of the whole amount.

HM Revenue & Customs will also be allowed to specify that the additional rate (50%) should be used by employers as a flat rate of tax (this may be relevant where your employee is employed by more than one business), and to apply the new 0T code to pension payments received while the pensioner continues to receive salary payments from your business.

You should ensure that:

• Your payroll operators are aware of the change, so that they can operate the 0T code if necessary.
• Your HR department is aware of the change so they do not automatically delay payment until the P45 has been issued.

Your business may also need to communicate the change to ex-employees who may have been informed that post-P45 payments would be subject to basic tax withholding.

What impact will the changes have?

• Your business will no longer be able to offer a cash-flow advantage when negotiating a compromise agreement. Ex-employees may suffer some disadvantages if termination payments are made after 6 April 2011 and the P45 has already been issued.
• The change will increase the risk that the amount of PAYE deducted after the issue of a P45 is more than the actual income tax liability. If your employee has little other taxable income in the tax year, they could have too much PAYE deducted from post-termination payments and have to reclaim some tax.
• You should no longer assume that it will be better from a tax perspective to make termination payments after issuing the P45. From 6 April 2011, the relative merits (from a cash-flow perspective) of pre- or post-P45 payment will need to be assessed individually in each case.

If you have any questions about the content of this article, please contact our Business Law Team

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