What are the changes to taxing termination payments from 6th April 2018?

Employers will have to change the way they tax termination payments where an employee’s termination date is on or after 6 April 2018. Tax and national insurance contributions (NICs) must be paid on all notice payments irrespective of whether there is a payment in lieu of notice clause in the contract (a PILON).   

Post-employment notice pay

Where the employee does not work out their notice period, the employer will have to calculate the employee’s “post-employment notice pay” (PENP). This is the employee’s basic pay for their notice period, or any part of the notice period not worked. There is a formula in the legislation for performing this calculation. Basic pay excludes overtime, bonuses, commission, gratuities, allowances, termination awards, benefits in kinds and amounts treated as earnings (such as share-based earnings).  

The employer will have to deduct income tax and NICs from the PENP (and pay employer NICs). The balance of the termination payment should then be taxed in the same way as it is now i.e. up to £30,000 can be paid without deductions for income tax and income tax will have to be deducted on the excess over £30,000. No employer or employee NICs will be payable.  

As is currently the case, statutory redundancy payments are always tax free.  

Areas of uncertainty

There are some areas of uncertainty which will hopefully be clarified when HMRC issues guidance, including what happens where an employer makes a termination payment following an employee’s dismissal without notice for gross misconduct. It would appear that the employer will still need to calculate PENP and deduct income tax, employee NICs and pay employer NICs and this will certainly be the safest course unless HMRC indicates otherwise.  

It is also unclear whether it is necessary to perform the PENP calculation where there is a PILON provision in the contract (or whether the employer can simply deduct tax and NICs (and pay employer NICs as it does now). In most cases this will not make a difference to the end result but there could be extra tax and NICs to pay where there is a salary sacrifice arrangement in place. The employer will normally make a payment in lieu based on the employee’s post-sacrifice salary. However, the definition of basic pay for the purposes of the PENP calculation includes the amount sacrificed, meaning that PENP will be larger than the PILON payment and additional income tax and NICs may be payable on the difference.  

What else should employers be doing about tax termination payments? 

Employers will need to make changes to their settlement agreements to reflect these changes.  

As in future there will be no tax advantages in not having a PILON provision in the employment contract, employers who do not already have them may wish to consider including one. This will give them the right to terminate employment with immediate effect by making payment of salary in lieu of notice without being in breach of contract.  This removes the risk of post-termination restrictions being unenforceable as a result of a breach of contract by the employer - as paying in lieu of notice where there is no contractual right to do so is a breach, albeit perhaps a technical one, but enough to invalidate the restrictions.    

If you would like help with any of these issues, please do get in touch.