The Government has published the second Finance Bill of 2017 which contains provisions relating to the taxation of termination payments.

The facts

A Finance Bill was published in March this year which contained proposed changes to the taxation of payments in lieu of notice on termination of employment. When the general election was called in April, the timetable for passing the Bill was shortened, and these (and other) provisions were dropped to accommodate the new timetable. The Government has now published the second Finance Bill of 2017, containing most of the provisions that were included in the previous Finance Bill.

Of particular interest to employers are the provisions which have been introduced to tighten and clarify the income tax treatment of termination payments. The key amendments and clarifications are:

  • Employees will pay tax and Class 1 NICs on the amount of basic pay that they would have earned if they have worked their notice in full, even if the employer has no contractual right to pay in lieu of notice. This is in contrast to the current position, where payments in lieu of notice (PILONs) on termination of employment benefit from the £30,000 income tax exemption if the employer does not have a contractual right to pay in lieu of notice.

  • The existing £30,000 income tax exemption will be retained and employees will continue to benefit from an unlimited employee NICs exemption for payments associated with the termination of employment.

  • Clarification that the tax exemption for termination payments in respect of "injury" includes psychiatric injury but does not include injury to feelings awards.

What does this mean for employers?

These measures apply to the tax year 2018 to 2019 and subsequent years.

Some employers have historically decided not to include PILON clauses in their contracts of employment so that employees can benefit from the current tax exemption. We recommend that these employers review their contracts of employment, as there will be no tax upside from April 2018 of not including a PILON in the contracts. Indeed, because any restrictive covenants are unenforceable where PILONs are made without a contractual PILON clause, there will only remain a potentially significant downside of not including a PILON in the contracts after April 2018.