Significant changes to taxation of termination payments

New tax rules, governing terminations, and termination payments, after 6 April 2018, will have a significant impact on employers (and employees) and the HR community who advise them.

The effect of the change is that, from 6 April, the basic pay element of all payments in lieu of notice now have to be taxed as earnings (and so subject to income tax and employee’s and employer’s national insurance contributions).  This is the case irrespective of whether there is a payment in lieu of notice (PILON) clause in the contract of employment, or not.  Any balance, as well as any statutory redundancy payment, will be classified as a termination payment and can be paid tax-free up to £30,000, and free of NICs.

Where previously employers could ‘sweeten’ the deal by paying a termination payment gross, without deductions for tax, on account of the absence of a contractual PILON clause, this opportunity no longer exits.   Employers will need to ensure that they are on top of the new rules, not only to manage the expectations of employees, but also to ensure that they are applying the correct amount of tax/NICs.  This will include getting to grips with the new concept of “post-employment notice pay” or PENP as it will inevitably become known, and the correct formula to be applied.

We’re anticipating an increase in the use of PILON clauses in employment contracts, as there is now no downside.  Employers will also need to review their standard settlement agreement terms dealing with taxation of termination payments.  Click here to download our factsheet which includes some examples of tax on termination payments.  Should you require any further advice on how to adapt your practices, contracts and agreements in light of these important changes to the tax rules, please get in touch with Tiggy or Emma.

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