Several changes to the tax treatment of termination payments are set to take effect in the coming years. However, the timescale for introducing some of the reforms has been complicated by the government’s recent decision to delay the National Insurance Contributions Bill. Here we provide an update on the latest situation.
Payments in lieu of notice (PILONs)
Under the current system, PILONs which are provided for in a contract of employment are subject to income tax and national insurance contributions (NICs). Conversely, ‘non-contractual’ PILONs may be treated as part of a termination payment and are therefore exempt from income tax up to the £30,000 threshold, and are not subject to NICs. These are effectively ex gratia payments in settlement of a breach to the employee’s employment contract.
However, the distinction between contractual and non-contractual PILONs is set to be removed from April 2018, meaning that PILONs will be treated as earnings rather than as termination payments and will therefore be subject to income tax and Class 1 NICs. This will be achieved by requiring the employer to identify the amount of basic pay (excluding expected bonuses), known as Post-Employment Notice Pay, that the employee would have received if they had worked their full notice period. This amount will be treated as earnings and will not be subject to the £30,000 exemption.
The existing £30,000 income tax exemption will be retained and employees will continue to benefit from an unlimited employee NICs exemption for payments associated with the termination of employment, such as redundancy pay. However, PILONs and payments exceeding the £30,000 threshold will be subject to employer NICs. It is anticipated that this will be collected in ‘real-time’, as part of the employer’s standard weekly or monthly payroll returns and remittances to HMRC.
According to the government, the change is intended to ‘bring fairness and clarity to the taxation of termination payments’, and to prevent manipulation of the rules.
All employers providing termination packages will need to consider the implications of these new rules. There is likely to be a notable impact on the cost of such packages for the employer, while individuals could also see the take-home pay from their termination package reduced significantly.
Note that the changes to the treatment of PILONs for income tax and Class 1 NICs are not affected by the delay to the NICs Bill and the measure will still apply from April 2018.
Foreign service relief
In addition, the government has confirmed that employees who are UK resident in the tax year in which their employment is terminated will not be eligible for foreign service relief on their termination payments. The changes will apply from 6 April 2018.
Termination payments over £30,000
The government previously announced changes to align the rules for tax and employer NICs by making an employer liable to pay Class 1A NICs on any part of a termination payment that exceeds the £30,000 threshold that currently applies for income tax.
This was due to take effect from April 2018 but in November 2017 the government decided to implement a one-year delay, so the changes will now take effect from April 2019. The delay has been welcomed by multiple payroll providers and employers, many of whom had expressed concerns over the added complications and perceived lack of communication on the subject.
To discuss how the changes to employment tax may affect you or your business, please contact us.