This time last year, HMRC started consulting on the future of the £30,000 tax exemption for termination payments. Under current rules, broadly speaking, contractual payments in lieu of notice (PILON) attract tax and national insurance contributions (NICs) as earnings but non-contractual payments on termination of employment are liable to income tax only on the amount exceeding £30,000 and are not subject to NICs at all.

The central plank of the reforms was to harmonise the treatment of contractual and non-contractual payments, so that all payments in connection with termination of employment would be subject to tax and NICs.

HMRC has published its formal response to consultation, confirming the proposals outlined in the initial consultation results in this year's Budget. The main changes, coming into effect from April 2018, are:

  • The distinction between contractual and non-contractual PILONs will be removed. Any payment that reflects what an employee would have received if they had worked their notice period will be taxed and subject to NICs, regardless of whether the employer has a contractual entitlement to make a payment in lieu. Other post-employment payments (such as compensation for loss of use of a company car during the notice period) that would have been treated as general earnings if the employee had worked their notice period will also be subject to tax and NICs.
  • The first £30,000 of a termination payment will remain exempt from income tax. The full amount of any termination payment will also continue to be exempt from employee NICs.
  • Employer NICs will be due on any part of a termination payment that is subject to income tax (in other words, anything over £30,000).
  • Most existing exemptions (including "on account of death or injury" and for the employee's legal costs in relation to the termination) will be retained. However, the exemption for payments for foreign service will be removed.
  • The exemption for payments for death and injury will not apply to payments for injury to feelings, so injury to feelings discrimination compensation paid as part of a termination payment will be subject to tax. This reflects the decision of the Upper Tax Tribunal earlier this year in Moorthy v HMRC.