When an employee leaves a business, settlement discussions can quickly become complex, especially when it comes to taxation. One of the most misunderstood areas of employment termination payments is PENP, or Post Employment Notice Pay.
Since 2018, HMRC has tightened the rules to ensure that payments covering notice periods are always subject to tax and national insurance. Yet many employers still assume that as long as a payment forms part of a settlement agreement, it falls within the £30,000 tax free allowance. Unfortunately, that is rarely the case.
What is PENP and Why Does It Matter?
PENP stands for Post Employment Notice Pay, which is the amount of pay an employee would have received had they worked their full notice period. Even if the employment ends immediately or by mutual agreement, HMRC treats that notional pay as taxable income.
Put simply, if an employee is paid in lieu of notice, that payment must be taxed. If they leave without working their notice, the equivalent value must still be calculated and taxed. PENP ensures that notice pay is taxed consistently, preventing it from being disguised as a non taxable termination payment.
How to Calculate PENP
To work out how much of a termination payment counts as PENP, employers must use a statutory formula:
(BP × D) ÷ P – T
Where:
- BP is the employee’s basic pay before termination (usually monthly salary)
- D is the number of unserved notice days
- P is the number of days in the last pay period
- T is any taxable termination payments already made
This gives you the amount that should be taxed as employment income.
For example, if an employee’s monthly salary (BP) is £3,000, their pay period (P) is 30 days, and they have 15 unserved notice days (D), then:
PENP = (3,000 × 15) ÷ 30 = £1,500 taxable.
If part of the termination payment has already been taxed (T), this is deducted from the PENP total.
Other Tax Considerations for Employers
It is not just PENP that needs attention when managing termination payments. Employers should also remember:
- Notice pay is always taxable, even within a settlement
- Payments for ongoing obligations such as confidentiality or non compete clauses are also taxable and subject to national insurance
- The first £30,000 of compensation for loss of employment can be paid tax free, but only once PENP and other taxable elements are removed
- Employer national insurance applies to payments above £30,000, though employees do not pay NI on settlement sums
- Disability related payments can be tax free if they relate solely to a recognised injury or condition preventing the employee from working
- Compensation for injury to feelings, such as in discrimination cases, can also be tax free, provided it is properly documented
Common Mistakes and How to Avoid Them
Misunderstanding PENP can lead to costly errors. If employers fail to apply the correct calculation, HMRC may later determine that part of the payment should have been taxed, leaving the employer liable for unpaid tax, NI, and possible penalties.
The safest approach is to check the tax treatment of each element in a settlement agreement and clearly set out what each payment represents. A well drafted agreement protects both the business and the employee from future disputes or unexpected liabilities.
The Takeaway for Employers
The rules around termination payments can appear complicated, but the principle is clear. Anything that substitutes for notice pay is taxable. The £30,000 exemption only applies once PENP and other taxable elements are excluded.
By understanding and correctly applying the PENP calculation, employers can settle matters confidently, remain compliant, and avoid unpleasant surprises later on.
If you need support with settlement agreement drafting, handling, or PENP calculations, get in touch with ECHR for expert guidance and practical advice.