The Taxation of Termination Payments
2nd May 2018Back to articles
The rules governing the taxation of termination payments are being tightened from 6 April 2018 by means of legislation to amend Chapter 3, Part 6 of the Income Tax (Earnings and Pensions) Act 2003.
Hitherto, where the employee's contract of employment contained an express payment in lieu of notice (PILON) clause, such payments were taxed at the appropriate rate. Where a PILON was not contractual, or the business making it did not routinely make such payments to departing staff, it could be regarded as compensation for breach of contract and paid free of tax up to a threshold of £30,000.
In order to ensure that the £30,000 exemption cannot be abused, the distinction between contractual and non-contractual PILONs has now been removed. The change applies to payments or benefits received on or after 6 April 2018, whether contractual or non-contractual, in circumstances where the employment also ended on or after 6 April 2018.
Employers are now required to calculate the amount of basic pay excluding bonuses, referred to as post-employment notice pay (PENP), the employee would have received had they worked their full notice period. This amount is taxable as earnings and subject to Class 1 National Insurance Contributions (NICs).
The first £30,000 of a termination payment that is not PENP remains exempt from Income Tax, and any payment made to any employee that relates solely to the termination of their employment will continue to have an unlimited employee NICs exemption.
The proposal to subject all termination payments above the £30,000 threshold to employer NICs, which was originally due to take effect at the same time, has been delayed until April 2019.
The legislation ensures that PENP calculations are not to be applied to statutory redundancy payments. These are always taxable as specific employment income and subject to the £30,000 exemption where appropriate.
Initial guidance on the new rules can be found in HM Revenue and Customs Employer Bulletin 70 at https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/684355/EmployerBulletin.pdf. More detailed guidance will be published in the Employment Income Manual in due course.
A further change is that Foreign Service Relief in respect of termination payments is to be removed. This will not apply to seafarers, however.
In addition, the legislation clarifies that the exemption from tax for payments for injury and disability is not intended to apply to payments for injury to feelings, except where the injury amounts to a psychiatric injury or other recognised medical condition.
Employers are advised to include a PENP clause in employees' contracts of employment as the tax advantage of excluding such a clause no longer exists. If you would like assistance in reviewing your contracts of employment to ensure they are fully compliant with current legislation, please contact Caroline Mitchell or Maxine Nutting in Devizes on 01380 722311.