Cash Q and A: It is possible to claim back cash on a taxed redundancy payment

Q As a result of a significant restructure within my department my role has been made redundant and, as such, I have been offered – and have accepted – voluntary severance. As a result of this I have paid over £9,000 to the tax man. For the first three months of 2013 (and perhaps longer dependent on the job situation) I will be unemployed as I am going to Canada to support my daughter and grandchildren through a messy divorce process. Can I claim a refund for some of the tax I have paid?

JN Dunfermline

A The answer is almost certainly yes, you can reclaim some of the tax suffered. The taxation of termination payments is a complex area, and it would perhaps be helpful if I set out the basics.

There is a common misconception that employees are entitled to receive up to £30,000 tax-free on the termination of their employment. This is not always the case, as some payments are automatically treated as earnings and taxed accordingly. Some examples of payments treated as “earnings” are salary, payments for unused holidays, bonuses earned but not paid and loans which are written off. In other words anything which you are entitled to under the terms of your contract, or by custom and practice of the employer, is liable to tax, and national insurance, as earnings.

In the scenario you outline, it is common practice for employers to pay sums in addition to contractual entitlements to entice employees to accept redundancy. These additional payments (and sometimes even the whole payment) are often structured as a compromise agreement (or compensation payment for breach of contract) with the aim of getting the first £30,000 tax free. Where these payments are made after your P45 is issued, and they exceed the £30,000 exemption, then the tax rate which is applied to the excess is 50 per cent. The only people who pay income tax at 50 per cent are those whose incomes exceed £150,000, whereas I would guess that your normal marginal rate is 40 per cent, so you could recover the excess.

Even if the payment was treated as earnings, and thus taxable under PAYE, there may be some scope to reclaim some tax charged. The way the code numbers work is that one-twelfth of your personal allowance, and one-twelfth of your basic-rate band, is allocated to your monthly salary.

If you have three months in which you are not working, then the code numbers applied to the final payment do not take the allowances into account. This means that in the final calculation of your tax liability for the whole year you would have 12 months personal allowances and 12 months basic-rate band available against your nine months salary.

In most circumstances this will generate a repayment of tax. To claim this repayment you need to contact HMRC on 0845 300 0627.

• Richard Brunton is the tax manager within the private client department at HBJ Gateley LLP.

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