The Government response to the consultation on the tax treatment of employment termination payments has finally been published.

The good news is that, despite suggestions and proposals to the contrary, the £30,000 tax exemption for termination payments is being preserved, albeit no longer covering any pay, bonuses or benefits which would have been earned in the notice period.

Although there is still a further consultation period, the changes are proposed to take effect from April 2018.


  • All payments in lieu of notice (PILONs) will be subject to tax and National Insurance contributions (NICs) in full. The £30,000 tax and NIC exemption will no longer shelter any PILON payments.
  • All elements of a termination payment covering or deemed to cover other income, benefits or bonuses foregone in or in respect of the notice period will also be subject to tax and NICs in full.
  • Payments not taxable as earnings under the above headings or otherwise (and which do not benefit from special exemptions) will continue to have a £30,000 income tax exemption. However, the NIC treatment will change. While the employee’s NICs exemption will continue to be unlimited, employer’s NICs (like income tax) will now be payable on amounts over £30,000.
  • The special exemptions will continue although the injury payments exemption will expressly no longer include payments for injured feelings and foreign service relief is being abolished (other than for seafarers).


In July 2015, the Government launched a consultation on simplifying tax and NICs on employment termination payments.

For background on the current position and earlier Government proposals click here.

The Government has now produced its final proposals and draft legislation.

Final proposals

  • PILONs and other notice-related payments

Currently, PILONs fall into two categories:

  • PILONS that are made under an express provision for the employer to make the payment in the employment contract are treated as earnings and subject to income tax and NICs in full, and
  • PILONs made without such a provision, which are in effect damages payments for notice not worked, and which benefit from a £30,000 tax exemption and an uncapped NIC exemption.

The Government has decided to remove the distinction between the two types of PILON. Accordingly, from April 2018, all PILONs (whether contractual or not) will be subject to tax and NICs in full (and will not be able to benefit from the £30,000 or NIC exemption).

Categorising what type of PILON payment is being made, worrying about whether it is an “auto-PILON” (ie the employer in effect by practice has created an express right to make a payment in lieu of notice even though it is not in the contract) or trying to restructure payments as damages, will all cease to be relevant to any tax analysis due to the level playing field that will operate for all notice-related payments.

In addition, all payments in lieu of existing benefits or potential bonuses which would have been taxable if the employee had worked their notice period will likewise be subject to tax and NICs in full.

Whilst the concept works in theory, the actual draft legislation which seeks to determine the amount of a termination payment which is fully taxable because of its links to the notice period and existing arrangements is complex and confusing. Minimum amounts are assumed to be in respect of notice pay and benefits even if not expressly stated in the termination agreement. It appears this will include any unfair dismissal payments (other than those made by way of a tribunal or court order) which almost always include amounts in respect of notice periods. Employers will be required to use a given formula to calculate the percentage of any termination payment which is automatically taxable and subject to NICs in full. The net result is disproportionate administrative and adviser cost and increased likelihood of errors, when a simpler system was a key aim of the reforms.

  • Other termination payments

Under current rules, where income tax is due on termination payments above £30,000 (because they are not under PILONs in contracts or otherwise earnings for tax purposes), there is no NICs charge on these payments, although there are also other exemptions to consider (see below) in special cases.

Despite suggestions of increasing or indeed lowering the income tax-free threshold for termination payments, the Government has decided to maintain the £30,000 threshold.

However, the Government has decided to align the income tax and employer NICs (but not employee NICs) treatment. This is in light of a concern about the potential for manipulation and unfairness to employees who are subject to income tax on termination payments over £30,000 whilst their employers are not subject to employer NICs.

From April 2018, employer NICs will therefore be due on termination payments if they are subject to income tax because they are more than £30,000. As with income tax, employer’s NIC will only be payable on the excess above £30,000. The employee NICs exemption on termination payments will remain. So if a relevant termination payment of £35,000 were made, £5,000 would be subject to income tax and employer’s NICs but there would be no employee’s NICs.

Unfair dismissal and redundancy payments will still remain eligible to benefit from the £30,000 exemption. However, in the case of unfair dismissal payments made under an agreement as opposed to a court or tribunal order, the £30,000 exemption cannot apply to notice-related amounts.

  • Other exemptions and reliefs continue (except foreign service relief)

There are various exemptions, and reliefs that apply to termination payments in addition to the £30,000 threshold. If the relevant conditions are met in full then there is no income tax liability even on payments over £30,000, nor is there any NIC liability. Among other payments, these include payments made:

  • because of the death, disability or injury of the employee,
  • under certain tax-favoured pension arrangements,
  • where the employee has a certain type of foreign service, or
  • in respect of certain legal costs.

The Government has decided to retain the above exemptions and their tax and NIC treatment except foreign service relief, which is being abolished other than for seafarers.

The Government has also announced that it is making a legislative amendment to clarify that the tax exemption for injury does not apply in cases of injured feelings unless they amount to a psychiatric injury. This reflects what HMRC considers to be the correct interpretation of existing legislation, despite recent cases to the contrary.

  • No new exemptions

Although the consultation considered the possibility of new exemptions for payments connected to discrimination, the Government has confirmed it does not intend to introduce any new exemption.


It is hoped that the final consultation being conducted will result in the draft legislation being simplified by removing the convoluted method of determining the amount of a termination payment which is fully taxable and subject to NICs as deemed employment income relating to notice period not served. Whilst the overriding objectives are relatively simple, the current draft legislation is complex and unhelpful.

HR departments will need to become familiar with whatever changes are legislated for in due course (and, if there is no change, with the new calculation methods) though with implementation not until April 2018, there is still plenty of time to adapt to them. Given that the distinction between contractual and non-contractual PILONs will, for tax purposes, fall away, there would appear to be little reason for employers not to include contractual PILONs as standard once the proposed legislation comes into effect in 2018. There may also, after 2018, be tax benefits in having a court or tribunal order for a payment as opposed to an agreement but other costs may outweigh the benefits of this.

It also remains to be seen whether the reduced after-tax amount of many termination payments for employees and the increased employer’s NIC costs for many employers leads to any adjustment in payment size.

To access the Government response document, click here. The deadline for responses is 5 October 2016.