News & Insights

Piling on the changes

Christian Meredith investigates the upcoming changes to tax on termination payments.

From 6 April 2018, a new regime will apply to payments in lieu of notice (PILON) paid on termination of employment. The intention of the change is to tax (and subject to class 1 national insurance contributions (NICs)) as earnings the basic pay an employee would have earned had they worked their notice period in full.

Currently payments on termination that are made under a contractual PILON clause are taxed as earnings but, if there isn’t a PILON, an equivalent payment can sometimes be made tax free (as part of the £30,000 allowance) as it comes under a “damage for a breach of contract”.

The changes will require employers to treat any part of a termination award that reflects basic pay for all or part of the employee’s notice period that is not worked, even if there is no PILON clause in the employee’s contract as earnings. This part of the award will therefore be subject to tax and NICs.

A termination award is defined as a payment or other benefit received directly or indirectly in consideration of, in consequence of, or otherwise in connection with the termination of an employee’s employment. This does not include statutory redundancy payments which automatically benefit from the £30,000 allowance.

HMRC has said that the new rules apply only where both payment and termination occurs on or after 6 April 2018. Employers who have any potential terminations coming up soon and want a non-contractual PILON to benefit from the £30,000 exemption, should ensure that the date of any proposed terminations falls before 6 April.

As a practical issue, employers must consider taking care in separately identifying and labelling payments in the settlement agreement. A single lump sum, for example, that is not split into separate elements may be taxed entirely as earnings. If employers are unsure of how tax on termination payments will operate, they may be able to seek clearance from HMRC.