On 6 April 2011, the Income Tax (Pay As You Earn) (Amendment) Regulations 2011 come into force and will affect the PAYE treatment of termination payments made to ex-employees after a P45 has been issued.

At present, if a taxable termination payment is made after the P45 has been issued, then the employer will deduct tax at the basic rate (20%). The employee is then responsible for declaring the amount of the termination payment in their tax return for the relevant tax year and paying any further tax due. Whilst this does not change the overall amount of tax that is payable, it does provide a cash flow advantage for employees who pay tax at the higher (40%) or additional (50%) rates.

From 6 April 2011, however, if a taxable termination payment is made after the P45 has been issued then the employer must deduct PAYE at the full 20%, 40% or 50% rates. This could lead to ex-employees overpaying tax and, as a result, having to reclaim the money via their tax return. The regulations therefore largely remove the current cash flow advantage to employees who pay tax at the higher or additional rates. General guidance for employers post 6 April 2011:  

  • Where possible, make termination payments before issuing the P45 in order to ensure (so far as possible) that the correct amount of tax is deducted and avoid, for example, a basic rate taxpayer having to reclaim overpaid tax through self-assessment if he/she does not immediately get another job.
  • If payments are made after the P45 has been issued then it may be beneficial to stagger the payments i.e. use monthly instalments because each separate payment is subject to PAYE independently and account is not taken of the earlier payments when working out the PAYE on later payments. The key factor here is that the date of entitlement must be staggered.
  • It may still be advantageous to defer payment to additional rate taxpayers (i.e. those paying at 50%) until after the P45 has been issued because the new tax code will lead to a lower immediate charge (although the balance will have to be paid later when the ex-employee's personal tax return is submitted).