Severance payments and the academy trust: what you need to know - PART 2

An agreed exit for school staff via a settlement agreement may be trickier than you think…

An agreed exit may seem like an easy option to smooth the departure of a member of school staff. Settlement agreements can provide peace of mind and value for money in some circumstances, but it is important that all parties go into the negotiation process with their eyes open so that expectations are not falsely raised and financial and governance obligations overlooked. Having the right information at your fingertips when opening off the record settlement negotiations with colleagues and their trade union representatives can save considerable time, money and conflict later in the process.

In the second part of our two-part article, we look at the key things which academy trusts considering severance payments should know.

Please click here to read Part 1 on compliance with the Education and Skills Funding Agency (ESFA) rules on severance payments.

The new tax rules on termination payments (from 6 April 2018)

The most important point to take away from this article is that the effect of the new tax rules is that notice pay or its equivalent is always taxed as earnings; whether as contractual pay in lieu of notice (PILON) or as a non-contractual payment. It is irrelevant how the payment is labelled by the employer. Any rounding up of a payment based on notice pay (as might have been proposed under the old rules) will also have no impact on the application of the new rules.

If the contract includes a right to a PILON

In this case, notice pay under the contract will be subject to deductions (as was previously the case) and the new rules will not apply.

Where there is no contractual PILON

It is most often the case that teachers' and school support staff contracts do not include a PILON. In this case, the amount which would have been paid for any unworked notice must be calculated (based on actual pay during the last pay period).  This is called Post-Employment Notice Pay (PENP). Any PENP within a severance payment will be subject to tax and National Insurance contributions (NICs). The notice period in question is the notice the employee would be entitled to from the employer.

How will this work in practice?

Let's take an example. Mrs Best is an MFL teacher who has been going through a capability procedure and has raised complaints about the process, including discrimination complaints.

Mrs Best would be entitled to 3 months' notice from the academy trust. She earns £3,000 gross per month. A settlement agreement is proposed including a severance payment of £15,000. No notice will be worked. There is no right to pay in lieu of notice in her contract. £9,000 of the payment (pay for the three month notional notice period) will be subject to tax and NICs, reducing considerably the amount Mrs Best actually receives. The remaining £6,000 will be exempt from tax as a payment in connection with termination coming within the £30,000 tax exemption threshold under sections 401-416 Income Tax (Earnings and Pensions) Act 2003.

Where some or all notice is worked

If the member of staff works the full notice period, there will be no "Post-employment Notice Period" and no PENP. In that case, any termination payment is likely to be payable without deductions. Academy trusts should ensure that they have a paper trail showing that notice was given and worked.

However, there are risks for both the employer and the employee in giving notice unilaterally. If the school gives notice, this is effectively a dismissal and could give rise to an unfair dismissal claim if the settlement agreement is not ultimately agreed. If the employee gives notice, this is a resignation. The risk for the employee is that the school might accept this without going on to agree any settlement terms. There is also a question as to whether the school would have any basis on which to make a severance payment where a resignation had already been received under the ESFA rules (see Part 1 of this article for details). To protect both parties, it is therefore advisable for the settlement agreement itself to record that notice has been given on the date of the agreement. You should be aware that HMRC may seek documentary evidence to support the academy trust's tax treatment of any severance payment.

Where some but not all the notice period is worked, this will reduce the impact of the new rules. If Mrs Best were to work one month of the three month notice period, the amount subject to deductions would be £6,000 (two months' pay).

Employees on reduced pay

PENP is based on the amount the employee earned as basic pay in the last pay period before termination. Broadly, where pay is reduced, this is the figure which is used for the calculation. If Mrs Best were to be on half pay, for example due to sickness absence or contractual maternity pay, in the last month before termination, the calculation would be based on half pay for three months and so deductions would be lower. If pay has reduced to nil, the PENP calculation will also be nil.

There is some uncertainty as to whether Statutory Sick Pay or Statutory Maternity Pay should be included in the PENP calculation. HMRC guidance indicates that these payments should be included as part of basic pay, but commentators have suggested that this may not reflect the meaning of the tax legislation. As a very new area of the law, such uncertainties have yet to be tested in the tax tribunal or courts.

ACAS settlements and tribunal awards

The new tax rules extend beyond settlement agreement payments to any "relevant termination award". This includes payments made during and after the early conciliation process through an Acas COT3 agreement. It is also likely to include awards made in tribunal.

Redundancy Pay

The main exception to the new rules is that the amount due to a redundant employee as statutory redundancy pay (SRP) can be paid tax free.

Contractual enhancements to SRP are not exempt. This means that tax and NICs will have to be deducted from any amount paid over SRP. 

Managing expectations

Employees are unlikely to know about this recent change to the tax rules. It is also possible that some trade union representatives do not have full information about the implications of the rules.

Teaching staff, who may be entitled to a full term's notice from the academy trust, will be particularly impacted by these rules. In many cases, the whole of a settlement sum will be subject to deductions. It is therefore essential that any settlement offer is clearly stated to be subject to tax and NICs and that you make clear that this can have a significant impact on take-home sums. Trusts should be aware that increasing the amount of an offer simply to mitigate the tax impact on an employee will not be justifiable under the ESFA rules. If the impact of the new tax rules is overlooked at the outset of negotiations, raised expectations may mean agreement is very difficult to reach.

Further guidance

This is a technical area of the law. We recommend that academy trusts take tax and legal advice on specific cases. It is also possible to refer a particular arrangement to HMRC for advance clearance where there is doubt about the application of the new rules. HMRC guidance on the new rules can be accessed here.