Taxing Termination Payments.

By Andrew Knorpel on 25th August 2016

Just over a year ago, we wrote about the Government’s proposals to simplify the taxation of termination payments by reducing the scope for tax-free payments and introducing a complicated exemption.

Well, the Government has now published its response to last year’s consultation exercise and it’s not as bad as it might have been.  Although all payments in lieu of notice (“PILON”) (both contractual and non-contractual) will be taxed in full from April 2018, there will be no qualifying period of service or redundancy requirement for genuine compensation payments to benefit from the first £30,000 being tax-free.  However, once you get to £30,000, the balance of any payment will be liable to both tax and employers’ national insurance contributions – they’re presently NIC-free.  The PILON will be calculated as including all salary, other payments and the value of taxable benefits in kind which would have been received during the notional notice period.

Draft legislation has been published for further consultation, but (assuming there are no substantive changes), how might the new law change the way you do things?

1. At present, if there is no contractual PILON clause in the contract of employment, any PILON made is technically a breach of contract which generally means that it may be paid tax-free (up to £30,000).  Yippee for the employee.  However, this means that the employer can’t rely on any post-termination restrictions in the contract.  Not yippee for the employer.  Under the new rules, as neither party will be able to benefit from not having a PILON clause, you might as well have one and maintain the enforceability of your post-termination restrictions.

2. Some generous employers make PILONs even where the employee has worked some or all of what could have been their notice period.  At present, if there’s no PILON clause, it makes no difference whether a severance payment includes any part of a PILON (up to £30,000 of total compensation paid).  In the future, however, if you’re proposing to be similarly generous, you should ask your employee to work as much of their notice period as possible.  This would mean that their taxable PILON forms a smaller proportion (if any) of their overall severance payment.  This rationale can already be applied where there is a PILON clause.

A few other changes to be made by the draft legislation include the general abolition of foreign service relief and clarification of the taxation of injury to feelings payments on termination.

One final thing, please remember that payments in lieu of accrued holiday will always be contractual and therefore taxable.  However, such payments need only represent the period up to the termination date.  You don’t have to include a sum for holiday which would have accrued through the notional notice period.

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