The rules as to the taxation of lump sum termination payments made after the issue of the P45 changed on 6 April 2011. In the case of larger payments the new rules will have a significant effect on the amount of tax that has to be deducted.
The first £30,000 of any payment made purely in connection with termination of employment can still be paid free of tax. However, the employer is now required to apply the OT PAYE code when taxing sums in excess of £30,000. The effect of this is that the first £2,916.67 of such sums is taxed at the basic rate of 20%, the next £9,583.33 is taxed at 40% and any remaining amount at the highest rate of 50%.
Depending on the employee’s income for the year as a whole, it may be possible for the employee to reclaim some of the deducted tax. It is no longer possible for the employee to enjoy the cash flow advantage which was available under the old rules, under which tax had to be deducted only at the basic rate of 20%, leaving the employee to account for the difference between basic and higher rate when submitting a tax return many months later.
This update is for guidance only and is not intended to be a substitute for legal advice on specific facts.
