HMRC clamps down on termination payments

Can termination payments of up to £30,000 still be paid tax free after 6 April 2018? Yes, provided however that no part of the termination payment represents unworked notice.

Old Position

Prior to 6 April 2018 if there was a contractual right to pay in lieu of notice in an employment contract (commonly referred to as a PILON) and payment in lieu of notice was made, then the payment would be subject to deductions of income tax and national insurance contributions. Conversely, income tax and national insurance contributions were not necessarily payable if an employer paid its employee in lieu of notice when there was no contractual right to do so. By way of example, if an employee was paid £25,000 in lieu of notice and there was a PILON in his contract, that payment would be both taxable and subject to national insurance contributions.  If however there was no PILON in the contract the £25,000 could arguably be paid tax free.  This meant that two employees in actually the same position who were both terminated and paid in lieu of notice could receive different amounts, depending on whether or not there was a PILON in their contract.

New Position

As can be seen, the tax treatment of termination payments arguably gave rise to inequity. HMRC has now introduced changes to ensure that any payment made on termination of employment that would have been taxed had the employee actually worked out their notice, will be taxed however it is dressed up in a settlement agreement or otherwise.

This means that from 6 April, any payment in lieu of notice (whether or not there is PILON in the contract) will be subject to the deduction of income tax and national insurance contributions. It is still early days and there is some confusion as to how certain payments will be treated, including whether contractual redundancy payments can still be made tax free (subject to the £30,000 limit). Certainly statutory redundancy can be paid tax free but there is some doubt in relation to enhanced redundancy payments.

The new provisions that were brought in require certain calculations to be carried out to determine what element of a termination payment is taxable as post employment notice pay (ie unworked notice) and what is not. This arguably means that a portion of what might otherwise be tax free could in fact be subject to tax, but time will tell as to how HMRC interprets the new rules.

Certainly, when making a termination payment including under a settlement agreement it would be wise to separate out what part of the payment represents post employment notice pay which will, in all circumstances be taxed, and what is a genuine termination payment which should be payable free of tax, subject of course to the £30,000 tax free limit.

It is also worth noting that any part of a termination payment that exceeds £30,000 will be subject to the deduction of income tax in the usual way and, in addition employer’s national insurance contributions will also need to be paid, this is another change brought in on 6 April.

This guide is for general information and interest only and should not be relied upon as providing specific legal advice. If you require any further information about the issues raised in this article please contact the author or call 0207 404 0606 and ask to speak to your usual Goodman Derrick contact.