Redundancy –taxation of payments

Redundancy is never pleasant for either employers or employees, but understanding the tax position can at least remove some of the financial uncertainty. Whether you’re managing redundancies as a business owner or facing redundancy yourself, the tax treatment of payments varies significantly depending on the type and amount involved. This guide walks through the key rules that apply under current HMRC legislation.

Statutory Redundancy Payments and the £30,000 Exemption

The most important threshold to understand is the £30,000 exemption for statutory redundancy payments. Under Income Tax (Earnings and Pensions) Act 2003 (ITEPA), the first £30,000 of genuine redundancy payments is entirely tax-free. This applies to both employees and the employer claiming the deduction.

For statutory redundancy calculations, HMRC follows the Employment Rights Act 1996 formula: one week’s pay multiplied by your age and length of service, up to a maximum of 20 weeks’ pay. Weekly pay is capped at £571 (current tax year), so the maximum statutory redundancy is around £11,420 per employee—well below the exemption threshold.

However, the £30,000 exemption extends beyond statutory payments. It also covers contractual redundancy payments and ex gratia payments (voluntary payments made at the employer’s discretion). The key is that these must genuinely relate to the termination of employment.

Payments Above £30,000

Any redundancy payment exceeding £30,000 becomes taxable as earnings. The excess is subject to Income Tax and National Insurance contributions (NI). Employers must therefore operate PAYE on amounts above the threshold, and employees should expect this to be reflected in their final payslip or P45.

This can create a significant tax bill for employees receiving enhanced redundancy packages. For example, a £50,000 redundancy payment would mean £20,000 is taxable. At the basic rate of 20%, that’s £4,000 in income tax alone, plus employee NI at 8% (£1,600), totalling £5,600 in tax and NI. Employers may choose to “gross up” the payment to cover tax, but this must be negotiated separately.

Employer Contributions and Company Perspective

From the employer’s viewpoint, redundancy payments are tax-deductible as a business expense, provided they’re genuinely incurred in closing down or reorganising the business. However, the treatment differs slightly for statutory versus discretionary payments:

• Statutory redundancy payments qualify for full tax relief against profits.
• Additional payments (the excess over statutory) also qualify for relief, but HMRC scrutinises whether these are genuinely commercial and not disguised remuneration.

If your business is making multiple redundancies, keep clear documentation showing the basis of selection, calculations, and the business reason. This protects you during any HMRC enquiry and demonstrates good practice to employment tribunals should disputes arise.

Directors leaving their own company should also note that director’s redundancy can raise additional considerations—particularly regarding IR35, if you operate through a limited company, or whether the payment represents a disguised dividend.

Reporting and Administration

Employers must report redundancy payments to HMRC via Real Time Information (RTI) through payroll software or directly to the PAYE Service. The payment appears on the employee’s P45 (or P60 if paid during employment), and employees must declare any taxable portion on their Self Assessment tax return if they’re required to complete one.

Employees who receive redundancy but have no other income in the tax year may not need to complete a Self Assessment return—HMRC should refund overpaid tax automatically. However, if you have other employment income or self-employment, you’ll need to file a return to ensure correct coding.

Practical Steps to Take Now

If you’re planning redundancies, speak with your payroll provider or accountant early. They can help calculate payments correctly, apply PAYE at the right time, and document everything properly. If you’re an individual facing redundancy, ask your employer for a clear breakdown of the payment and confirmation of how much is statutory versus discretionary—this affects your tax bill significantly.

For tailored advice on your specific redundancy situation—whether you’re making redundancies or facing them—contact Severn Accounting. We can help you understand the tax implications, optimise payments within the rules, and ensure proper reporting to HMRC. We’re here to help.