PENP: Why Your Settlement Is Taxed More Than You Expected

If you have been offered a settlement and the net figure came back lower than you expected, the reason is usually PENP. It is the least understood part of a termination payment and it catches people out constantly, including people who have taken advice.

The thing people assume, and why it is wrong

The common belief is that the first £30,000 of a termination payment is tax free. That exemption is real, but it does not apply to everything, and PENP is the mechanism that decides what it does not apply to.

Before April 2018, whether a payment in lieu of notice was taxed depended on whether your contract contained a PILON clause. If it did, the payment was taxed as earnings. If it did not, it could often be paid tax free within the £30,000. That distinction was removed.

Now the rule is the same for everyone: the part of a termination payment that represents basic pay for notice you did not work is taxed as earnings, with income tax and National Insurance, whatever your contract says.

The formula

HMRC sets it out in its Employment Income Manual, and it comes from section 402D of the Income Tax (Earnings and Pensions) Act 2003:

((BP × D) ÷ P) − T

• BP — your basic pay in the last pay period ending before the trigger date.
• D — the number of calendar days in the post-employment notice period, meaning the notice you did not work.
• P — the number of calendar days in that last pay period.
• T — anything already being taxed as earnings in connection with the termination, typically a contractual PILON.

Two rules sit on top of it. If the result is negative, PENP is nil. And if it comes out higher than the total termination award, it is capped at that total.

Note that BP means basic pay. Bonus, commission, overtime and benefits are not in it. That is one reason the number often looks lower than people expect for a high earner on variable pay.

What it does to your settlement

The order of operations is what matters.

Your termination award is split in two. The PENP slice is taxed as general earnings — income tax and Class 1 National Insurance, both employee and employer. Only the remainder gets the benefit of the £30,000 exemption.

So a settlement of £35,000 with a PENP of £9,000 does not give you £30,000 tax free and £5,000 taxed. It gives you £9,000 taxed as earnings, and the remaining £26,000 falling under the £30,000 threshold.

Statutory redundancy pay sits outside this calculation. It is not part of the relevant termination award for PENP purposes.

Where the arithmetic goes wrong

PENP is calculated in calendar days, not working days, and not months. Using a monthly figure straight across is one of the most common errors, and it usually inflates the taxable slice.

The days in your last pay period matter too. A 28-day February and a 31-day March give different answers from identical pay.

And the trigger date is not always the date you think. It is generally the day notice is given where notice is given, or the last day of employment where a payment is made in lieu of the whole period.

None of this is obscure, but it is fiddly, and an employer's payroll getting it slightly wrong is common.

How to check the figure you have been given

• Ask for the calculation in writing, showing BP, D, P and T separately. A reputable employer will provide it.
• Check BP is basic pay only, and from the right pay period.
• Check D is counted in calendar days across the whole unworked notice period.
• Check whether statutory redundancy pay has been correctly excluded.
• If the numbers do not reconcile, raise it before you sign. Afterwards is much harder.

Our free calculators include a PENP calculator you can use to sanity-check what you have been offered. It is a cross-check, not tax advice — for a large or complicated settlement, an accountant is worth the fee.

What it does not change

PENP is a tax calculation, nothing more. It does not affect whether your dismissal was fair, whether you have a claim, or your tribunal time limits. Those run on their own clock while you negotiate.

It also does not change your statutory notice entitlement, which is a separate right. See our Employee Rights checker for what you are owed in notice terms.