The way that termination payments are taxed by employers is to change from 6 April 2011.
What is the Change?
Currently any sum paid to an individual who has left employment after the P45 has been issued is taxed at basic rate (20%), even if that person is a higher rate taxpayer.
Any additional income tax liability due from a higher rate taxpayer is settled by the individual with HMRC through self-assessment (and paid in the following January).
This may be the case in respect of contractual payments or compensation payments which exceed the tax-free amount of £30,000 (usually paid under a compromise agreement).
For payments made on or after 6 April 2011, employers must withhold income tax at the taxpayer’s marginal rate (40% for higher rate tax payers and 50% for those with income of over £150,000) from payments made even after the P45 has been issued.
What does this mean for employers?
In times gone by, when interest rates on savings were at a rate worth worrying about, this change might have made a difference to senior individuals who would otherwise have been able to earn interest on the deferred tax until the following January.
If those interest rates existed now, this change might give senior individuals negotiating exit packages another point to take against their employer.
But the reality is that, with interest rates as they are, the interest capable of being earned on the deferred tax, and the related negotiating leverage, are both negligable.
However, employers should ensure that the drafting of compromise agreements, in relation to payments to be made on or after 6 April 2011, is amended to provide that appropriate income tax deductions are to be made from relevant payments, not just basic rate deductions.