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In Brief: Tax on termination – what employers need to know

by Kelly Faulkner

In Brief: Tax on termination – what employers need to know

This month’s Autumn Statement confirmed that following on from its consultation over the summer, the Government will continue with its proposed simplification of the termination payment regime.  The £30,000 tax free allowance on certain elements of termination payments is to be retained – but not as we know it.  We outline what will be changing from April 2018. 

The Government revealed in its latest Budget an intention to review the tax and National Insurance contributions (NIC) treatment of termination payments in order to make the system “simpler and fairer”.  Despite speculation that the current £30,000 tax free allowance on certain elements of termination payments might be scrapped, the Autumn Statement confirmed the Government’s plans to keep it after all.  However, from April 2018, certain payments will no longer fall within this allowance, a development which could nonetheless signal significant change to current practice for employers and also the expectations of employees upon leaving.

Key changes from April 2018:

•   There will no longer be a differentiation in the treatment between contractual and discretionary payments in lieu of notice (“PILONs”).  Instead, all PILONs will be treated as earnings subject to income tax, employer and employee NICs. 

•   Although the exemption from income tax and NICs for termination payments up to the current threshold of £30,000 will be retained, all payments that an employee receives, or would have received, during their notice period will be taxable as general earnings.  Only the balance remaining will benefit from the £30,000 exemption.

•   Employer NICs will be payable on payments above £30,000. 

•   Payments for injury to feelings will fall outside the exemption for injury payments, except where this amounts to a psychiatric injury or a recognised medical condition.

It appears that the Government has dropped its controversial proposal to tax certain "post-employment" and "expected bonus" payments as earnings, confirming that income tax will only be applied to the equivalent of an employee's basic pay if their notice is not worked.  However, this change is to be monitored and the Government will address any manipulation of this rule.

Once the changes take effect, it seems likely that tax liability will increase and many employees will receive lower than expected payments.  This in turn may lead to disappointment and likely adversely impact upon the negotiating position of the employer in settlement discussions.  To assuage disappointment employers may wish to take steps to not only prepare financially but also communicate the changes to employees in advance.