Employers who are planning to make termination payments to departing employees on or after 6 April 2018 need to be aware of important reforms which will take effect on 6 April 2018.
The key point for employers to note is that the value of all notice periods not worked will become taxable and subject to both employer and employee National Insurance Contributions (NICs), regardless of whether there is a contractual payment in lieu of notice (PILON) clause, or not. This is a critical change to the existing position, where currently the value of a notice period can generally be paid tax and NICs-free where there is no contractual PILON clause in the employee’s contract of employment. The impact of this is to potentially increase costs to employers who may have to increase the value of a termination package to make it sufficiently attractive to an employee. It also makes the tax advantages of not having a PILON clause redundant, and increases the benefits of including one, not least so that any restrictive covenants will remain enforceable post-termination.
Payments made pursuant to a contractual PILON clause have always been – and will remain – subject to tax and NICs in full as general earnings.
So, in practice, what impact does the legislation have? In effect, it does not matter how much of the severance package the employer allocates to notice. What the new provisions require is that employers carry out a specific calculation to determine how much of the termination payment is deemed to be subject to tax and NICs as ‘post-employment notice pay’ (PENP). For these purposes, only basic pay, plus the value of any salary sacrifice arrangements, is taken into account. Once the value of the PENP has been established, any remainder of the payment will be subject to the £30,000 tax free exemption (so any remaining payment up to £30,000 will be free of tax and NICs, and anything in excess of £30,000 will be subject to tax only).
In many cases, the impact of the new legislation in practice (other than making non-contractual PILONs taxable) will be fairly limited, and the calculations relatively straightforward. This is particularly the case where an employee’s notice period is a whole number of months. However, the position is less straight forward where an employee’s notice period is expressed in weeks, where the calculation may become skewed by the date of the employee’s departure. It is also more complicated where salary sacrifice arrangements apply. This is key as it is common for contractual PILONs to confer entitlement to basic pay only, whereas the new calculations require the value of any salary sacrifice to be added on. Where salary sacrifice arrangements are in place, therefore, there will be an impact on the value of the PENP (and therefore the amount subject to tax and NICs), which will be higher than would apply if calculations were done by reference to the provisions of the contractual clause only. This may mean that, even where there is a contractual PILON and the employer has deducted tax and NICs on the notice pay actually paid, the PENP calculation results in an additional tax and NIC liability.