Changes to the tax treatment of termination payments

The beginning of a new tax year always heralds changes which businesses and, indeed employees, need to be aware of and that we need to share with our clients. This time, these have included an alteration to the taxation of termination payments – the payment somebody receives when their employment is terminated.

These changes, which were covered in clause 14 of the Finance Bill, particularly concern the tax treatment of pay in lieu of notice (PILON) – the payment given to somebody who leaves a position without serving their notice and takes into account what that person would have been paid, had they worked through their notice period.

Before April 2018, the payments which were made to somebody who was contractually entitled to them were subject to income tax and NI deductions, but if a person was not contractually entitled, then the payments were treated under a more beneficial tax regime, where a £30,000 exemption was available resulting in a reduction in the tax and national insurance liabilities.

Since the beginning of this new tax year, all payments in lieu of notice are now both taxable and subject to Class 1 NICs. This legislation requires the employer to identify the amount of basic pay that the employee would have received if they had worked their notice period, even if the employee leaves the employment part way through their notice period.

The amount is now treated as earnings and will not be subject to the £30,000 Income Tax exemption. All other termination payments will be included within the scope of the £30,000 termination payments exemption.

This means that individuals are now being treated in a similar way tax-wise, whether they are contractually entitled or not.

The Government says of the changes: “This measure is intended to bring fairness and clarity to the taxation of termination payments by making it clear that all PILONs, rather than just contractual PILONs, are taxable earnings. All employees will pay tax and Class 1 NICs on the amount of basic pay that they would have received if they had worked their notice in full, even if they are not paid a contractual PILON.

This means the tax and NICs consequences are the same for everyone and it is no longer dependent on how the employment contract is drafted or whether payments are structured in some other form, such as damages.”

The new tax regime has also cleared up any lingering confusion over ‘injured feelings’ and it clarifies that the exception for termination payments relating to injury, disability or death does not apply in the case of ‘injured feelings’. That said, it does still apply in cases of ‘psychiatric injury’.

This highlights the importance for employers to think about whether the payment can reasonably be said to relate to pre-termination discrimination and treat it accordingly.

As part of these changes, foreign service relief has been abolished. Put simply, employers who had worked abroad for a period of time could qualify for full or partial relief from tax on their termination payments, but this is now not possible. This marks a significant change to the tax position of employees returning to the UK after termination.

If you have any questions regarding changes to the tax treatment of the termination of employment, please do call us on tel: 01892 526417.