The government has commenced a consultation on the details of its proposed changes to tax treatment of termination payments.

Changes to taxation of termination payments have been heavily trailed for some time and in this year’s Budget the government announced that these would come into force in April 2018.

Some key elements will remain unchanged:

  • the exemption from income tax on the first £30,000 of a termination payment will remain;
  • any payment to an employee that relates solely to the termination of the employment contract will continue to have an unlimited exemption from employee national insurance contributions (NICs).

However, the following changes will come into force from April 2018:

  • termination payments that are subject to income tax on amounts in excess of £30,000 will be subject to employer NICs (whereas now, they are exempt from both employer and employee NICs);
  • all payments in lieu of notice (“PILON”) and certain damages payments will be taxed as earnings;
  • he exemption for payments relating to injury will not apply in cases of injured feelings unless they amount to a psychiatric injury or other recognised medical condition;
  • the foreign service exemption will be abolished.

What does this mean for employers?

Many employers will be relieved that the £30K exemption has survived, albeit subject to some changes. The exemption plays a vital role in aiding settlement of many employment disputes: in effect, it allows more money from an agreed settlement sum to reach the hands of the employee without additional cost to the employer and, in doing so, forms a vital bridge between the parties in resolving disputes by way of settlement.However, the changes to employer NICs will increase the cost of settlements to employers in many cases, and, as the consultation document states, it could "have a knock-on impact on employees who could end up bearing the cost through reduced pay-outs".

The blanket treatment of PILON payments as taxable will also be significant: currently, PILON payments are not taxable where there is no PILON clause (express or implied) in the employment contract, which can be a valuable exemption. The change will certainly simplify this area, but at the expense of another potential saving to the overall cost of a termination package.

Similarly, the removal of the injury exemption from injury to feelings cases will reduce one avenue for tax-efficient payment structures in cases of alleged discrimination where there could be grounds for an injury to feelings award. However, the taxation of such injury to feelings payments had already been thrown into question by recent court decisions; this change will finally clarify the position.

The cumulative effect of these changes could be significant: whilst the headline is the survival of the £30K exemption, employers may find that reaching a settlement with departing employees after April 2018 will be tougher - or at least more expensive. As that date approaches, it may be worth taking these changes into account and seeking expert advice in case departures can be accelerated to enjoy the benefit of the current rules.