We answer some frequently asked questions about changes to the taxation of termination payments, which take effect from 6 April 2018 onwards.
What are the main changes happening in April 2018?
The following are the most significant changes:
- Post-employment income: Where the employee does not work their full contractual notice period, income tax and national insurance contributions will be payable on the element of the termination payment which represents what the employee would have earned during the unworked portion of the notice period. This is known as “post-employment income” and is worked out using a statutory formula. That means that it will not necessarily be exactly the same as the amount that would have been payable under the contract for that period.
- Injury to feelings: The law has been changed to make it clear that payments for injury to feelings do not qualify for the separate exemption for payments on account of injury or disability, though payments for psychiatric injury will continue to qualify.
- Statutory redundancy payments: The new legislation provides that the new tax charge will not apply to statutory redundancy payments (or contractual redundancy payments up to an equivalent amount).
When exactly are these changes taking effect?
HMRC have recently confirmed that the new rules will only apply where the termination date was on or after 6 April 2018. The old rules will continue to apply where the employment was terminated before 6 April, even if the termination payment is made on or after that date.
In other words, for these new provisions to take effect, both the termination date and the payment date must fall within the tax year 2018/19.
What is staying the same?
The main rules about the tax treatment of termination payments will not change. They will continue to be taxable under the special regime applying to payments made “directly or indirectly in consideration or in consequence of, or otherwise in connection with, the termination of a person's employment”. That means the first £30,000 of these payments can still be made tax free if there is no post-employment income, with the balance being taxable unless a specific exemption applies. However there is another important change in the pipeline for 2019 (see below).
What about taxable payments in lieu of notice?
Any taxable payment in lieu of notice will in effect be deducted from the post-employment income. That means that from 6 April onwards there is no longer a tax benefit in making an equivalent payment by way of damages for breach of contract. This is currently normally possible if the employer has no express contractual right to make a payment in lieu of notice.
If I make a fully taxable PILON, can I be sure that no further tax/NI is due?
The short answer is no, not completely. That is because the statutory formula for calculating post-employment income does not necessarily produce the same answer as calculating the payment in lieu of notice (PILON) in accordance with the contract of employment.
One obvious example is the way that salary sacrifice arrangements are treated under the new rules. Normally a contractual PILON is calculated based on the employee’s net salary, but under the statutory formula the amount of salary sacrificed is added back in. The only safe way to find the answer is to run both calculations. With any luck, your payroll provider should be able to help you with this!
What about redundancy payments?
The treatment of statutory redundancy payments will not change. That means that statutory redundancy payments can continue to be paid free of tax, though they will count towards the £30,000 tax free threshold if other termination payments are made.
However, it is possible that the element of any contractual redundancy payment which exceeds the statutory maximum could be treated as post-employment income, even if the total payments being made to the employee in connection with the termination of employment do not exceed £30,000.
What is still in the pipeline?
As from 6 April 2019, employers’ national insurance contributions will be payable on the element of termination payments in excess of £30,000. They will remain exempt from employee’s national insurance contributions, even if over £30,000.