Well its all change in Employment Law today, one of those changes is the Income Tax (Pay As You Earn) (Amendment) Regulations 2011 coming into force which will affect the PAYE treatment of termination payments made to ex-employees after a P45 has been issued.

Previously, if a taxable termination payment was made after the P45 has been issued, then the employer will deduct tax at the basic rate (20%) using code BR. 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.

But as from today 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 using code OT which won’t take into consdideration the personal allowance. This could potentially 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.

So what should employers do as from today?:

• Where possible, make termination payments before issuing the P45 in an effort to ensure 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 they do 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

As Editor of Lawble, Gill helps business and individuals become better informed about their legal rights. Gill is a content specialist in the fields of law, tax and human resources.