EPN741: Taxation of Efficiency Compensation Payments

Audience

• Pension leads
• HR managers
• Payroll managers
• Finance managers

Summary

This guidance sets out how departments should apply the correct tax treatment to efficiency compensation payments made to employees upon dismissal.

Timing

Immediate

Detail

• This EPN should be used alongside EPN 584 and EPN 471.
• Departments are responsible for applying correct tax treatment to efficiency compensation when an employee is dismissed.
• Annex A provides detailed guidance on how efficiency compensation payments are correctly taxed, for employees leaving under Dismissal on grounds of efficiency.
• Departments must determine and apply the right tax treatment at the time of payment, using advice from the Centre of Tax Excellence.
• The first £30,000 of efficiency compensation is usually tax-free according to Section 403 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003).
• Any amount exceeding £30,000 is subject to income tax and Class 1A (employer’s) National Insurance contributions
• Payments related to injury or disability may be fully tax-exempt under Section 406 of ITEPA 2003.
• Departments must assess the nature of each case, especially regarding whether the dismissal stems from a disability/injury, to determine if the exemption under Section 406 applies.
• Departments must clearly distinguish efficiency compensation from other payments like redundancy or ex-gratia payments.
• Where there is uncertainty on s406 ITEPA, departments should use HMRC’s Non-Statutory Clearance Service with the employee’s consent. Departments may also seek support from the Tax Centre of Excellence
• Updated internal payroll processes and stakeholder co-ordination are essential to ensure compliance and consistency across government.

Contacts

If you have questions about this EPN or would like to receive EPNs in a different format, email: EPN@MyCSP.co.uk

Electronic copies of the Employer Pension Guide, current EPNs, and forms are in the Employer section of the Civil Service Pensions website.

Note: This notice is for employers. Please do not share it with scheme members.

Members can find information about their pension on the scheme website.