Legal briefing | Funds, Private Equity Funds | 06 Aug 2018

Tax on termination payments

Overview

On 6 April 2018, the way that termination payments are taxed is going to change. Employees will be taxed on notice pay, even where there is no PILON in the contract.

At the moment, tax treatment of termination payments differs depending on whether there is a payment in lieu of notice (PILON) clause in the employment contract. So with:

  • A PILON clause: the PILON payment is taxable and any genuine termination payment over that is tax free up to the first £30,000
  • No PILON clause: any termination payment can usually be paid tax free up to the first £30,000, even if it includes payment for the notice period (although some employers do choose to deduct tax from the notice pay).

From 6 April this will change so that, where the employee has not been given notice (or been given less than full notice) and there is:

  • No PILON clause: any termination payment will be deemed to include basic pay for the notice period (or balance of it) and this notice element will be taxable in full. It will also be subject to employer and employee National Insurance contributions. The £30,000 tax exemption will only be available for any additional termination payment on top of notice pay
  • A PILON clause, the same rules will apply but because the PILON payment will be deducted from the deemed notice pay, the end position will in most cases be the same as it is now (as outlined above).

The change will apply where both the termination date and the payment date fall on or after 6 April.

The new rules are a little unclear in some respects on precisely how the notice element should be calculated, including in relation to salary sacrifice arrangements, and HMRC will be issuing guidance in due course.

Employers should consider:

the likely tax treatment of

  • any settlements currently being negotiated, and
  • any settlements which have already been agreed where termination and payment will take place on or after 6 April
  • whether changes need to be made to template settlement agreements, to cater for the different elements of the termination payment
  • whether to include a PILON in all employment contracts, given that there is no longer a tax advantage to be gained from leaving one out.

Our Incentives and Remuneration Group, led by Mahesh Varia, has been working closely with HMRC on the new rules and advising clients on a variety of different practical scenarios. If you would like to discuss how these changes affect your business, please get in touch with Mahesh, or any of the Employment partners.

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