18 April 2018

New regime for taxation of termination payments in employment


Alison Paines
Partner | UK

From 6 April 2018 the tax treatment of payments in lieu of notice ('PILONs') paid on termination of employment has changed. Charities entering into settlement arrangements with employees need to be aware of these new rules.

Background

Under the current regime when employment is terminated broadly speaking, payments for contractual entitlements are taxed as if they were earnings from employment and non-contractual and ex gratia amounts are tax free up to £30,000.

A payment in lieu of notice or PILON is a clause in the employment contract that enables the employer to choose to make a payment in lieu instead of giving the employee notice of termination, thus bringing forward the date on which the employment ends. Because the payment is made under a clause in the employment contract it is treated as earnings of employment and must be taxed accordingly. It is also subject to both employer and employee national insurance contributions (NICs).

At present if there is no PILON clause, the employer may make a payment in lieu of notice free of tax and NICs.

The new regime

It is the tax treatment of non-contractual PILONs that has changed with effect from 6 April this year. Following this change, payments made in respect of what would have been noticed if the employee had worked their notice or been given notice of termination, will be defined as 'post-employment notice pay' (PENP) and will be subject to tax and NICs. Employers will need to divide any payments they make on termination into amounts treated as earnings, which will be fully taxed and amounts benefiting from the existing £30,000 tax exemption. PENP will fall into the former taxable category.

The new legislation is somewhat complex and includes formulae for calculating PENP in cases where employees are paid monthly and cases where they are paid at different intervals or are entitled to notice that is not expressed in months (such as statutory notice, which is calculated in weeks). The calculations are based on the notice that the employer is required to give, even if the employee has given notice and the employee's notice is less than that of the employer.

When is a PENP calculation needed?

PENP calculations will not be needed if the only payment that is being made is a contractual PILON.

It is not currently clear whether they will be needed if a payment consists of a contractual PILON and an ex gratia termination payment and further guidance is awaited from HMRC, which has indicated that it will be updating its Employment Income Manual in due course.

Statutory redundancy pay is not included in PENP and will always be subject to the £30,000 exemption. Contractual redundancy pay will however need to be included in the PENP calculation.

Action points for charity employers

1. This is a good time for employers to review their employment contracts. There will now be no advantage in a contract that does not contain a PILON and there may be a case for introducing them for two reasons:

• There has always been a slight risk that because terminating a contract without notice and paying in lieu when there is no contractual right to do so is a breach of contract, any post termination restrictions in the contract could be in jeopardy if the contract is not terminated on notice.

• There is an argument (which is not fully resolved because of some ambiguities in the new legislation) that it will be simpler to calculate what tax is due on termination of employment if there is a PILON in the contract.

2. Employers who use a template settlement agreement should also review the terms to ensure that they are not inconsistent with the new rules.

PILON clauses do however need to be carefully drafted to ensure that there are no ambiguities in the way they operate.

The latest HMRC Employer Bulleting contains an item on the new regime and can be accessed here.

If you would like to know more about this change please speak to your usual Withers contact or Christina Morton, our professional support lawyer.

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