Tax changes – termination payments

In July last year, the government published a consultation document on the income tax and national insurance (NI) treatment of termination payments. It has now published the results, along with draft legislation.

This can be a complex legal area and employers considering the tax treatment of termination payments are advised to take professional advice. Broadly, the present position is that payments made to an employee which relate solely to the termination of their employment (and have not come about due to an existing contractual entitlement) can be paid free from deductions for income tax, up to a maximum of £30,000. These payments are also exempt from employer and employee NI contributions, without limit.

Presently, if an employment contract contains a payment in lieu of notice (PILON) clause then the PILON payment will be subject to tax and NI. If there is no PILON clause, then it may be possible for the PILON payment to be tax free. For more information about PILON payments, please see our article, ‘understanding notice’, click here.

The proposed changes, which are expected to take effect from April 2018 are in summary:

All PILON payments will become subject to income tax and Class 1 NI contributions, whether or not there is a PILON clause in the contract of employment;
Aligning the rules on income tax and NI so that employer (but not employee) NI contributions will become payable on termination payments in excess of the £30,000 exemption;
Clarifying that the existing exemption from tax for payments relating to injury, does not include payments for injury to feelings.

The government hopes that these changes will prevent manipulation of the rules. The consultation paper emphasises that under the new rules, it will remain the case that the first £30,000 of any termination payment will remain free from deductions for income tax and that termination payments of any amount will be free from employee NI contributions. PILON payments remain subject to both employer and employee NI contributions.

To view the consultation paper, click here

25 August 2016

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