Following last week’s article on Taxation of Termination and Injury to feelings awards, Tom Pimenta reviews the risks and provides some recommendations on terminating employees under the new tax rules.
What has changed?
Any terminations that take place on or after 6 April 2018 now require that any sum equivalent to payments of basic pay during an employee’s notice period must be taxed and have employee National Insurance Contributions deducted in the normal way.
This is regardless of whether the notice is worked in whole or in part, and irrespective of whether there is a PILON clause. The new calculations for Post-Employment Notice Pay (“PENP”), as explained last week, cover this.
What about benefits?
If the employee was contractually entitled to the benefit and it relates to past or future service such as provision of a company car then it is likely to be taxable, in full, as earnings.
The following payments (amongst others) are not normally taxable and do not go onto form P11D so they will not suddenly become taxable as a result of the new rules:
- Childcare vouchers below the appropriate amount as set by the government;
- Disabled peoples’ costs of travel between home and work – provided they have a substantial and long term disability; or
- Provision of parking for a car, motorcycle or bicycle at or near the place of work.
What happens if a company pays the incorrect tax or national insurance contributions?
Failure to deduct and pay the correct tax or national insurance contributions on a termination payment can result in HMRC fines, penalties and interest payments being levied. The employer rather than the employee is primarily responsible for these payments and HMRC will contact the employer for payment. HMRC can conduct a PAYE audit, which can go back over the previous 6 years. This can be a far reaching and invasive investigation for a business and future PAYE audits will also focus on previous non-compliance.
Strategy to avoid issues
- The HR team should work closely with payroll and the finance team when making plans to terminate an employee’s contract to ensure that the changes to the tax regime are properly handled in any termination package.
- The tax advantages of not having a PILON clause no longer exist. Employers would be well advised to include a PILON clause in contracts going forward. Such clauses will enable an employer to make a payment in lieu without there being a breach of contract, which destroys any contractual restrictive covenants and confidentiality clauses.
- Employers may now have to pay more for their termination payments as employees are only really interested in the net amount that they receive so are likely to demand more.
- Making a payment into the employee’s pension may enable an employer to reduce the overall termination payment, which is subject to tax. However, employers will need to take specific advice on this to ensure that they do not fall foul of any anti-avoidance rules.
- Make sure that any tax indemnity clauses in settlement agreements are properly drafted. If employers are required to pay fines, they will want to ensure that the former employee will reimburse them.