As one of its money savings measures, the Government is introducing changes, on 6 April 2011, which will affect the tax deducted by employers on payments made after termination and how tax is calculated for new employees with no P45. Although these measures seem fairly innocuous, they may affect the structure of termination payments, and the negotiations up to termination.

The Changes  

From 6 April 2011 HMRC will require employers to use code OT (zero allowance) in the following situations:  

Termination payments  

Currently HMRC requires tax to be deducted at basic rate (code BR) on any taxable termination payments made to an employee after the employment has ceased, if the payments have not been included in their P45.  

If the individual is liable to tax at the higher or additional rate, this results in an underpayment which HMRC has to collect from the employee at a later stage. It can be considerably advantageous to the employee from a cash flow perspective as they will not need to pay the tax until they complete their self-assessment form after the end of the next tax year. At that point the individual may have tax allowances that can be deducted. This is often an incentive to an employee in agreeing a termination package, and a helpful negotiation tool for the employer when finalising termination payments.  

From April 2011 HMRC will require employers to use the code OT (zero allowance) for payments made after termination. This will ensure that tax is deducted from payments at the basic, higher or additional rate of tax as appropriate, at the time of payment. If the employee has tax allowances that could be set against the tax at a later stage, it will be up to them to claim the allowance when they complete their self-assessment form several months later.  

New employees with no P45  

Currently if the new employee fails to provide a P45 before their first pay day and does not sign a P46, the employer will complete the P46 to the best of their knowledge and submit it to HMRC to update the employee’s record and issue a tax code if necessary. In the meantime the employer should use code BR. If this happens, it is likely that higher paid employees will pay less tax than is due and an underpayment will arise at the year end. Again this can be advantageous to the employee from a cash flow perspective.  

From 6 April 2011 HMRC will require employers to use code 0T (zero allowance) instead of BR, so that the employee will pay tax at the basic, higher and additional rate as appropriate. This is to ensure that high earners cannot delay payment of their full liability by failing to provide a P45 or not signing a P46.  

Employees who receive occ upational pension payments whilst still in employment  

Currently, employers are told to use the existing tax code until a new code is issued. However this means that employees may receive more personal allowances than they are entitled to which results in an underpayment of tax at year end.  

From 6 April 2011 HMRC requires employers to use code OT (zero allowance).  


The tax code changes could have a significant impact in the following situations.  

  1. Where a compromise agreement has already been signed but payments under that compromise agreement are due to be paid from 6 April 2011:  
    1. if the compromise agreement specifies that payments made from 6 April 2011 will be taxed at basic rate, this contradicts the employer’s legal obligation to tax the payments using code OT. Generally the legal obligation will override the contractual obligation, however this will depend on the specific wording of the contract. If you have negotiated and signed a compromise agreement which makes a termination payment after 6 April 2011 and refers to deductions being at basic rate only, we can advise you on your options;
    2. if the compromise agreement does not specify how the payments made under it are to be taxed, there is no conflict between the legal position and the contractual position. However, the eventual sum paid to the former employee following the tax changes may be less than the sum the employee was expecting when the compromise agreement was signed. Consider notifying the former employee of the position to help manage their expectations.  
  2. Where a compromise agreement is currently being negotiated, the fact that there will be no tax saving from 6 April 2011 may be an important negotiating point. The employee is likely to want to receive any agreed payments before the changes take effect as the cash flow advantage of the current system is likely to be beneficial to higher-rate tax payers.  
  3. From 6 April there will be no advantage in paying the individual after the P45 has been issued. In fact, the individual is likely to be marginally better off receiving payment before the P45 as this will be based on the employee’s normal code with the benefit of their personal allowances.  


These tax changes will apply to contractual payments which go through the employer’s PAYE system such as salary, payment in lieu of notice payments and contractual bonuses. It will still be possible to make a termination payment under sections 401 to 404A of the Income Tax (Earnings and Pensions) Act 2003; the changes will impact on sums in excess of £30,000. Care should be taken in drafting compromise agreements now which deal with payments on or after 6 April to ensure that it is clear that tax will be deducted at basic, higher or additional rate as appropriate on payments from 6 April.