Making Exit Payments – A Q&A for Employers

In what circumstances can I make a payment to an employee for them to leave?

Often employers will offer enhanced exit payments to departing employees in circumstances where they wish to exit an employee without following a full, formal procedure. This is usually where the circumstances are such that they would like to make an additional payment to an employee out of goodwill or where the employer pays the employee in exchange for them waiving any potential legal claims they might have.

How should I broach this with the employee concerned?

You should take legal advice before having such a conversation as there are ways in which this can be done which give the employer protection from this being “used in evidence” or held against them in future – such as having a “Without Prejudice” conversation if there is already an existing dispute or a “protected conversation”.

What am I obliged to pay?

In most circumstances, the employee will be contractually entitled to their notice pay (as set out in their contract, or the statutory minimum whichever is greater) and payment in lieu of their accrued but untaken annual leave entitlement.

If the employee is genuinely redundant, they will also be entitled to a statutory redundancy payment and legally the calculation for this must be set out in writing.

If the employer wants the employee concerned to waive any legal claims and/or to keep the payment(s) confidential then they will most likely have to pay extra for this and make an ex-gratia payment in addition to the contractual entitlements.

If the employee agrees to sign a settlement agreement, then it is also customary for the employer to contribute towards the employee’s legal fees in this regard.

Can I make any payments tax-free?

It is a common misconception that employees are entitled to the gross amounts of any exit payments made to them.

The tax rules are complex and employers and employees will need to take their own advice on each and every set of facts.

Tax rules state that employers must tax employees on any payments of Post Employment Notice Pay (PENP).  These rules can catch payments made under settlement agreements and other exit payments where an employee has not worked and been paid for any or their full entitlement of notice (whichever is the greater of employer contractual notice or statutory notice).

Except in very limited circumstances, only payments made in excess of the properly calculated PENP amount can be paid without deduction for tax and employer National Insurance and a £30,000 limit applies to these payments, with any further amounts also being taxable.

Payments of accrued but untaken annual leave must also be subject to PAYE deductions.

Redundancy payments can generally be made tax-free but are included within the £30,000 exemption.

Employers should be very cautious when making exit proposals to employees about giving assurances about the amounts that employees will receive or the tax status of various payments until they have taken advice on those proposals. Failure to do so can result in employers having to “gross up” elements of their payments to ensure the employee receives the net amount promised and resulting in the exit being significantly more expensive than anticipated.