EPN297 - Change to taxation of compensation lump sums

Date posted: 01/03/2011

Audience: This Notice will be of particular interest to:

• HR staff dealing with redundancy exercisesAction
• To note the changes and actions for staff
• To bring the information to the attention of staff currently undergoing redundancy exercises

Timing: Tax changes effective from 6 April 2011

HMRC has recently confirmed a change to the tax treatment of compensation lump sums which Capita must apply to payments from 6 April 2011.

At present they apply basic rate tax of 20% to the amount of lump sum over the tax free £30,000.

From 6 April 2011 HMRC have confirmed that Capita must apply tax on a ‘month 1’ basis using the applicable tax bands. This treats the balance of the compensation payment as if the individual earned that amount each month.

The tax bands from 6 April are:

£0 - £35,000 @ 20% = maximum of £2,917 payment in one month]

£35,001 - £150,000 @ 40% = maximum of £9,583 per month (£12,500 less £2,917)

Over £150,000 @ 50%

Example

Gross lump sum = £76,040.10

Less exemption = £30,000.00

Taxable balance = £46,060.10

Under current rules the tax deducted at the time of payment would be at

£46,060.10 x 20% = £9,202.02

Capita would tell HMRC of the payment made, and the amount of tax deducted. If the individual is liable to pay tax at the higher rate, they would be contacted by HMRC to complete a self assessment form so that HMRC can assess and charge the correct amount of tax.

Under the new tax rules, the tax would be applied to the £46,060.10 as follows:

£2,917 @ 20% = £583.40

£9,583 @ 40% = £3,833.20

£33,560 @ 50% = £16,780

Total tax deducted = £21,196.60

The individual would have to apply to HMRC to assess the correct amount of tax payable and reclaim any excess tax paid

This change to tax treatment will reduce the amount of compensation that many staff expect to receive, and will involve them in having to claim refunds from HMRC.

To mitigate the effect on staff we need:

• to tell them in advance wherever possible of the tax treatment so that they can make their financial decisions accordingly.
• to tell them how to initiate the assessment and reclaim the excess tax, where applicable.

Attached to this EPN is a notice that we ask you to draw to the attention of your staff if you are currently running a redundancy exercise.

We will expand the redundancy guidance for members to include this information.

Capita will tell staff when they pay the compensation amount and direct them to HMRC for assessment and refund as applicable.

Key messages for staff

• Compensation lump sums paid will in many cases be lower than expected because of the tax deducted.
• Capita must apply the tax as directed by HMRC even if it is clear that the member of staff will not be due to pay the full amount collected, and will be due a refund.
• HMRC set the policy and any queries about the policy should be directed to them.

Staff will have to contact HMRC via their Tax Office to correct the amount of tax payable.

Contacts

Enquiries about content, distribution or to receive in a different format

employerhelpdesk@cabinet-office.x.gsi.gov.uk
01256 846414
Employer Helpdesk
Civil Service Pensions
Grosvenor House
Basing View
Basingstoke
RG21 4HG