From 6 April 2018 important changes will be coming into force in relation to the way termination payments are taxed.
When an employee’s employment is terminated, that employee is generally entitled to notice. If there is a Payment In Lieu Of Notice clause (PILON) in the employment contract, the employer is entitled to terminate the employee’s employment immediately, and pay them a sum in respect of the salary (and sometimes benefits) the employee would otherwise have accrued had they actually served the notice period. Where the employer elects to rely upon a contractual PILON, the amount paid pursuant to this PILON will be subject to tax and national insurance contributions. This will continue to be the case after new changes come into force in April.
However, in a situation where the employment terminates and there is no PILON in the employee’s contract, employers have typically been able to pay a sum (which represents the employee’s earnings during the notice period) as damages. This allows the first £30,000 of the amount to be treated as tax exempt.
In the past HMRC has tried to clamp down on employers who do not put PILONS into their employment contracts (and thereby manage to pay the equivalent of the notice pay without deduction of tax) where the employer operates a practice of making payments to their employees in lieu of notice as a matter of routine. However, the rules that are now coming into place on 6 April 2018 go one further by providing that, even where there is no contractual PILON in the contract, employers will nonetheless have to deduct tax from any amount which equates to “post-employment notice pay”. This will essentially mean that the tax benefit to termination payments which was previously enjoyed where there was no contractual PILON will no longer be available.
The “post-employment notice pay” will essentially be the basic salary the employee would have earned had they remained in employment for the notice period. How this is calculated will depend upon 1) how regularly the employee is paid 2) the length of their notice period and 3) the amount of unworked notice. In the event that all of these amounts are expressed in months, the answer is relatively straightforward. In other situations a formula will need to be applied based upon the employee’s basic pay for the last pay period, the number of days in the post-employment notice period and the number of days in the last pay period. Payments outside of basic salary (for example, overtime, bonuses etc.) will not be included in the calculation.
The overall effect is that the deemed post-employment notice pay will now be taxable. Nonetheless, other amounts paid as a termination payment which are not due under the contract may still benefit from the tax free £30k exemption.
There are also further plans to make amounts over the £30k tax threshold liable to National Insurance Contributions. Currently, such amounts over the £30k threshold are only subject to Income Tax. However, these changes have been postponed until April 2019.
There are also other important changes coming into force on 6 April 2018, including the abolition of Foreign Service relief for UK resident employees (who are not seafarers), and the narrowing of the exemption for payments made in respect of injury to feelings in discrimination claims.