HM Revenue & Customs has published draft legislation which will change the way employees are taxed on their termination payments from April 2018


Currently, as long as they are not being paid under a contractual pay in lieu of notice ("PILON") clause, employees may receive the first £30,000 of any termination payment free of income tax and national insurance contributions (NICs). Above this amount income tax, but not NICs, is payable.

Pathway to change

The government has been consulting on the tax status of termination payments since July 2015. In the Budget this year, it was announced that termination payments which are subject to income tax on any amount in excess of £30,000 would also be subject to employer NICs.

HM Revenue & Customs responded to the consultation on 10 August with the publication of draft legislation which is expected to apply from April 2018. Changes will be introduced in the Finance Bill 2017 and a future National Insurance Contributions Bill.

What changes are being made?

As published the draft legislation contains some significant changes to how both income tax and NICs Contributions apply to termination payments. The headlines are:

  • All PILONs will be treated as earnings and subject to income tax and NICs regardless of whether or not there is a PILON clause in the employee's contract of employment. Currently non-contractual PILON payments can be made free of tax and NICs.
  • Termination payments over £30,000 will be subject to employer (but not employee) NICs.
  • Payments apportioned to cover "injury to feelings" will be excluded from the general exemption for injury payments, except where they relate to a psychiatric injury or a recognised medical condition. This will remove the current conflict in case law we have on this issue.
  • The current tax exemption for employment outside the UK (the foreign service exemption) will be abolished, except in relation to seafarers.

What does this all mean?

Although these changes will certainly make terminating employment more expensive for employers, it does provide some welcome simplification in what has become a complex area. Some of the more complicated proposals which were included in the consultation, such as linking tax relief to length of service, have been rejected.

The good news for recipients of termination payments is that the first £30,000 of any payment they receive will continue to be exempt from income tax and that no part of any termination payment, whether over or under the £30,000 limit, will require the payment of employee NICs.

Employers may wish to bring forward planned terminations in order to benefit from the existing regime, which is expected to be in place until April 2018.