Statutory redundancy can be paid to any employee who has been in two or more years' continuous employment with an employer. The calculation is made according to a formula, based on age, length of service and weekly pay which is capped at £330 per week. The payment is based on:
0.5 weeks' pay for each full year of service where age during year less than 22;
1.0 weeks' pay for each full year of service where age during year is 22 or above, but less than 41;
1.5 weeks' pay for each full year of service where age during year is 41 or more.
Tax-free statutory redundancy cannot be paid to yourself if you are Self employed, In partnership or an office holder without a contract of employment. As an office holder you will have fiduciary duties and if a liquidator or administrator takes over your company the quantum of any redundancy payments may well be taken out of your hands. Assuming that the business is solvent when it closes, then statutory redundancy may be paid legally.
Up to £30,000 may be paid tax and NI free but payments other than statutory redundancy need to be considered rather carefully. Tax penalties as well as interest will be charged by HMRC if an employer fails to make the correct deductions.
Earnings include any salary, wage or fee, any gratuity or other incidental benefit of any kind obtained by an employee consisting of money or money's worth, and anything that constitutes an emolument of the employment. This includes tips and payments which derive from the employment, but need not be paid by the employer. Caught as "earnings" are any contractual payments made on redundancy, for instance payments in lieu of notice (PILONs).
Even where there is no written contracts, the employers' past actions will count.
Loans written off are classed as earnings, as will also be subject to NIC. It is better for the employee to repay the loan and the employer to make a higher redundancy payment if this can be covered by the £30,000 exemption.
Dividends are not classed as earnings and are taxed normally, and do not count for statutory redundancy purposes.
Pension payments into approved schemes are a slightly grey area as tax treatment is dependent on whether the termination payment is part of PILON.
HMRC Employment Income Manual says that a lump sum paid into an approved pension scheme in compensation for loss of employment will only be tax-free if the payment is properly regarded as earned by past services (essentially, it is part of the individual's retirement benefits) or the loss of employment is due to ill health.
There is no liability to NICs, unless the payment is under a contractual PILON or otherwise liable to NICs.
Payments to and under a non-approved retirement scheme - HMRC will try and argue that payments made to older employees (over 55s) are made on retirement and taxable. Evidence needs to be gathered to show that the redundancy is genuine - i.e., not for retirement/tax purposes. This could cause problems for owner managers.
When payments are not taxed as earnings, s 401 to 416 of ITEPA 2003 apply:
The first £30,000 of payments that fall within s 401 is exempt from tax, any excess will be subject to tax and NICs. This section also applies to payments made in relation to offices or employment, so will cover termination payments made to non-executive directors.
If a payment relates to foreign service there may be a partial or complete exemption from tax too.