NIC on termination payments – are you getting it right?

Your payroll returns may be highlighting an NIC underpayment to HMRC

NIC on termination payments

HMRC leverage payroll data to identify potential errors so that they can target enforcement activity. HMRC have identified that many employers are underpaying Class 1A NIC on termination payments and this article considers what employers could do to ensure they haven’t underpaid, and how they might respond to any communication from HMRC asking them to review their position.

When is Class 1A NIC due on termination payments?

Broadly, non-contractual termination payments are taxable only to the extent that they exceed the £30,000 exemption. Until 6 April 2020, such payments did not attract any NIC charges. However, from 6 April 2020, any excess over £30,000 is both taxable and subject to Class 1A NIC.

Class 1A NIC on termination payments is an employer only liability but, unlike Class 1A NIC associated with benefits-in-kind, it is administered via payroll and reported under Real Time Information (RTI).

How has HMRC’s enforcement approach developed?

Consistent with their growing use of analytics to identify potential errors, HMRC have been analysing employer payroll records (RTI submissions) and writing to employers where they believe that Class 1A NIC has been underpaid on termination payments. If an employer has underpaid Class 1A NIC, in addition to making good the underpayment, interest and penalties may be charged.

In addition, once an issue has been identified, HMRC will also review the tax treatment. As a reminder, the rules on the taxation of Payments In Lieu Of Notice (PILONs) were introduced in April 2018. Under the old rules, the tax treatment of a PILON could depend (amongst other things) on whether a contractual PILON clause was present. From 6 April 2018 onwards, this ceased to be the case. Broadly, since 6 April 2018, basic pay for the entire notice period is treated as salary for PAYE and NIC purposes.

What should employers do?

Failure to operate PAYE and NIC correctly can result in reputational damage and penalties – including personal liabilities for Senior Accounting Officers (SAOs) in companies within the SAO regime – as well as interest on late payment when settling the outstanding amounts due.

Employers should therefore regularly review their processes, controls and payroll withholding to ensure that their obligations are met.

Where employers receive a ‘nudge’ communication saying that their RTI returns indicate that a PAYE/NIC failure might have arisen, this should be taken seriously and viewed as an opportunity to engage with any issues proactively and minimise the risk of a formal HMRC enquiry.

Given the complex tax and NIC treatment of termination payments, even in the absence of a specific ‘nudge’ from HMRC, employers should review the treatment they applied to each component of termination packages agreed with former employees. In particular, employers should confirm that they have:

  • Correctly applied the ‘post-employment notice pay’ (or ‘PENP’) rules to any PILONs; and
  • Calculated and correctly reported any Class 1A NIC due on any termination payments in excess of the £30,000 exemption.

Any errors identified should be disclosed to HMRC and the outstanding amounts settled as soon as possible. Weaknesses in systems and processes that resulted in PAYE and NIC failures should also be identified, and appropriate steps taken to minimise the risk of recurrence.

KPMG’s Employment Solutions team includes tax and payroll professionals who can support on all aspects of payroll compliance. Please contact the authors, or your usual KPMG in the UK contact, if you would like to discuss the income tax and NIC treatment of termination payments, and payroll compliance risk further.