Currently, the employer is only responsible for deducting tax from a valid termination payment on any amount in excess of £30,000, at the basic rate i.e. 20%. An employer would usually use the tax code BR in these circumstances.
In the event that there is an additional tax liability over and above the basic rate, for example because the employee is a higher rate tax payer, the former employee is personally responsible for accounting for this through the self-assessment process.
Position from 6 April 2011
Employers will, from 6 April 2011, be required to deduct the full tax liability on any amount of a termination payment in excess of £30,000 through the PAYE system using the tax code OT. The OT tax code assumes that the former employee has no personal allowances available and requires the employer to tax the termination payment in excess of £30,000 at the former employee's appropriate rate of tax (basic 20%, higher 40% or additional 50%). This change impacts on payments made on or after 6 April 2011, even if they were agreed before this date.
This is a shrewd decision by HM Revenue and Customs to accelerate the receipt of higher rate tax payments, from the end of the tax year in which they are made to the point of payment, in order to improve cash-flow.