Redundancy payments – tax pitfalls

Caroline Harwood, CTA FCA, Partner, BDO - Croner-I

Long gone are the days when employers could assume the first £30,000 is tax free when making staff redundant. Caroline Harwood, partner and national head of employment tax at BDO, explains the tax and NIC rules for termination payments.

The current state of the UK economy, characterised by subdued growth forecasts and rising employment costs, particularly from the April 2025 employer National Insurance (NI) hike and minimum wage increases, are likely to contribute to increased redundancy and downsizing programmes over the next one to two years.

While increased redundancies appear probable, especially in the short term, the labour market is described as undergoing a ‘slowdown, not a collapse’, with job losses remaining relatively subdued so far (eg, HR1 redundancy notifications (advance notification redundancies) were low in July 2025).

The NIC impact may have peaked for some employers, and mitigating factors like interest rate cuts or productivity gains could temper the scale of redundancies. However, if stagnation persists or geopolitical risks escalate, redundancy programmes could accelerate beyond current expectations.

What are the implications of redundancy?

Some organisations are stating that redundancies are necessary as the sums just don’t add up in the current climate. We have also seen well-known businesses from hospitality to financial services downsizing in recent weeks. As many have been dealing with staff shortages rather than excesses for years, the redundancy process may not be as familiar as it once was, so a reminder is timely.

It is very important that employers who plan to make termination payments ensure they get the tax and national insurance contribution (NIC) position right. The related rules are complex. It is, therefore, vital that employers carefully consider the rules to avoid unpaid liabilities, penalties and the reputational risk of getting it wrong.

We have only focused on the UK income tax and NIC aspects below, but employment law advice should also be sought to ensure the rules relating to redundancy, including the consultation process, establishing the notice period and the statutory redundancy pay entitlement are met. In addition, if the individual has worked overseas during their employment, the tax position will be more complex and there may be reliefs available.

Tax considerations

The tax and NIC treatment of termination payments is fact specific, and it is important to manage the process correctly in order to avoid unexpected liabilities, penalties and reputational damage. For those businesses within the Senior Accounting Officer (SAO) regime, it is imperative to demonstrate an appropriate compliance process.

In practice, most elements of a typical termination payment are liable to tax and NIC.

Long gone are the days of simply assuming the first £30,000 is tax free.

Since 2018, legislation has deemed payments related to the termination of employment to be ‘relevant termination awards (RTAs)’, and we need to consider a two-step process to the amounts of any tax and NIC liability.

The 2018 legislation introduced the post employment notice payment (PENP), which is surprisingly complex to calculate. Once calculated, this must be compared to the RTA. There are a number of potential outcomes.

• If the PENP value exceeds the full value of the RTA, then the employer is required to deduct tax and employees NIC from the termination payment via PAYE, and account for employers’ NICs.

• If the PENP value is less than the full RTA value, any excess of the RTA may qualify for the £30,000 tax relief mentioned above. We say ‘may’ not ‘will’, because there are further complications to consider.

• If the RTA exceeds the PENP value and the £30,000 tax relief, the excess will again be subject to tax under PAYE. However, it will be liable to Class 1A and not Class 1 NICs, so there is no further deduction for the employee.

£30,000 tax relief

The tax relief is only available if there are no other parts of the legislation that make the termination payment taxable first, and a liability to NIC usually follows a tax liability.

To determine if the relief is available, we need to establish the elements making up the termination payment. There is often more than one individual element, particularly in the case of settlement agreements. Each one should be considered and the source determined. The following are some common examples.

• Restrictive covenants included in the original employment contract will not generate a tax/NIC issue if included in a settlement agreement, but adding new or additional covenants would make an associated payment taxable/NICable.

• Where an employee is at or near retirement age (which for practical purposes could be anyone over 50 – albeit that is aspirational for many!), HMRC will consider whether the payment is a form of lump sum pension payment. If HMRC take this view, tax can potentially be charged at 45% irrespective of the tax rate the employee normally pays.

• If the employer operates a salary sacrifice arrangement, or if they are included as part of the settlement (eg, paying part of the termination payment into a pension), this may not be tax free as it is added back for PENP calculation purposes.

• If the employee has worked overseas, other reliefs and tax provisions can apply that can impact to what extent the termination payment is liable to UK tax/NIC.

• If the employee intends to return as a consultant or in some other role operating on a self-employed basis or via a personal service company (PSC), any element of the RTA that has not been subject to PAYE/NIC can be at risk.

Clearly, qualifying for the £30,000 tax relief can be difficult, but other reliefs may be available in specific circumstances and should not be overlooked. For example, if the employee is suffering from ill health (physical or mental), a termination payment can potentially be completely tax/NIC free.

So how complex is it really?

Depending on the fact pattern, there are as many as 63 different data points that you may need to consider for each termination payment calculation. Problems discovered after the employee has left and the relationship has ended can be difficult to put right, and HMRC will inevitably approach your business to remedy any identified shortfall in PAYE and NIC.

Therefore, wherever circumstances allow, aim to calculate the tax/NIC profile of a termination payment well in advance so that costs of termination arrangements are kept under control. We would also recommend taking specialist employment tax advice from a chartered tax adviser in order to navigate the maze and ensure that savings for the employer and benefits for the former employee are not eroded by any unnecessary tax, NIC liabilities or penalties for getting it wrong.