Post-Employment Notice Pay (PENP): A Guide
Contract Termination Guide
For HR managers of growing businesses in the UK, understanding the nuances of employment law is essential. One area that often causes confusion is the termination of employment contracts. In particular, the rules surrounding Post-Employment Notice Pay (PENP) can be complex. This article provides a clear explanation of PENP, how it is calculated, and its tax implications, helping you tackle this tricky aspect of UK employment law.
What is Post-Employment Notice Pay (PENP) in the UK?
So, what exactly is post-employment notice pay? In simple terms, PENP is the amount of basic pay an employee would have received if they had worked their full notice period. Since April 2018, the rules around termination payments have changed significantly. Now, any payment an employee receives for a notice period they do not work is treated as taxable earnings. This means it is subject to Income Tax and National Insurance Contributions (NICs), just like regular salary.
PENP is a statutory calculation to determine the portion of a termination payment that relates to unworked notice. It ensures this amount is taxed correctly, even if the employment contract doesn’t contain a specific Payment In Lieu of Notice (PILON) clause. It’s important for an employer to understand this distinction. A termination award can include both a taxable PENP amount and a separate tax-free element (up to £30,000), such as statutory redundancy pay.
Recent changes in UK legislation
The legal landscape for termination payments is not static. A key change affecting PENP took effect in April 2021. This change addressed how PENP is calculated for employees who are paid monthly but have a notice period in weeks or days. To create a fairer system, the formula was updated. For example, if an employee is paid per calendar month, the calculation must now adapt to the specific number of days in that relevant month.
Staying abreast of such changes is vital for compliance. For a broader understanding of terminating contracts, you might find this article on everything you need to know about terminating contracts helpful.
How is PENP calculated?
The post-employment notice pay calculation follows a statutory formula. The goal is to isolate the gross basic earnings an employee would have earned during their unworked notice period, even if they performed zero work. There are two main formulas for the PENP calculation: a simpler one for when an employee is paid monthly and their notice period is in whole months, and a more complex one for other scenarios.
The principle of the calculation involves identifying the employee’s basic salary from their contract, the length of their notice period, and any part of that notice they have already worked. Basic pay, for the purposes of the PENP calculation, excludes things like discretionary bonuses, overtime, and most regular allowances. However, it does include amounts given up under salary sacrifice arrangements. For an employee working their last day, the employer must determine the number of unworked days in the notice period.
Common pitfalls for UK employers
Several common pitfalls can easily catch an employer out. A frequent mistake is incorrectly identifying ‘basic pay’. Another area of error is the notice period itself; the calculation must be based on the statutory or the contractual notice period, whichever is longer.
Employers must also be careful with a contractual PILON. Even if a termination payment is described as ‘ex-gratia’, meaning ‘given as a gift’, if it relates to the notice period, it will still be subject to PENP rules. Similarly, when an employee is on garden leave, or gardening leave, they are still technically employed and receiving their regular pay, which is taxable as usual.
Misunderstanding the interaction of a PILON clause in an employment contract and the statutory PENP calculation can lead to significant errors and liabilities sanctionable by HM Revenue and Customs (HMRC).
UK tax implications of PENP
The primary purpose of the PENP calculation is to ensure the correct tax is paid. The key takeaway is that the PENP amount is fully taxable as income. It is therefore treated as earnings, and is subject to both income tax and employee and employer NICs. This is a significant change from the pre-2018 rules, where some notice payments could be paid tax-free.
Any part of a termination payment that is not PENP may still qualify for the £30,000 tax exemption. This includes statutory redundancy payments. It is essential to clearly break down the components of a termination payment to ensure the correct tax treatment is applied. For employees, understanding their final gross pay is complex, but this guide to understanding what’s on your payslip will be of help.
When to seek legal advice
Given the evident complexity of the rules, it is always advisable for employers to seek professional advice. You should consider consulting with a specialist in any of the following situations:
When negotiating a settlement agreement with an employee.
If the employee has a complex salary package, including shares or unusual benefits or allowances.
In any redundancy situation, to ensure all payments are handled correctly.
If you are unsure about any aspect of the PENP calculation or its interaction with the employment contract.
Getting the right expert advice can save your business time and money, and ensure you are treating your departing employees fairly and legally.
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