As confirmed in the 2017 Spring Budget, the tax rules governing termination payments will change from 6 April 2018.
The term ‘termination payment’ is typically used as a generic summary for a lump sum payment, which is normally (but not always) made to an employee at the time the employment comes to an end. The current rules governing the taxation of termination payments are complex and over recent years, have been subject to manipulation by some employers seeking to minimise income tax and NIC liabilities. The forthcoming changes seek to clarify the rules, particularly in relation to the existing £30,000 tax-free exemption for genuine redundancy payments.
Under the existing rules, it is necessary to look at whether payment in lieu of notice (PILON) is the contractual right of the employee. Broadly, if a contractual right exists, it will be fully taxable as earnings. This ‘contractual right’ element has provided a degree of scope for manipulating arrangements to take payments outside the taxable earnings boundaries – and in doing so, for potentially escaping the charges to tax and NICs.
From 6 April 2018, all PILONs, rather than just contractual PILONs, will be treated as taxable earnings. Therefore, under the new rules, all employees will pay tax and Class 1 NICs on the amount of basic pay that they would have received if they had worked their notice in full, even if they are not paid a contractual PILON. This means the tax and NICs consequences are the same for everyone and it is no longer dependent on how the employment contract is drafted or whether payments are structured in some other form, such as damages.
Aligning income tax and NICs
The existing £30,000 income tax exemption for genuine terminations payment will remain. However, the National Insurance Contributions rules will be aligned with the tax rules so that, from 6 April 2018, employer NI contributions will be payable on the elements of the termination payment exceeding £30,000. The employer NIC charge will be achieved through Class 1A contributions.
As with most anti-avoidance measures, it is likely that HMRC will monitor how these changes are operated and, if perceived misuse of the rules is detected, further changes can be expected.
Although the existing £30,000 exemption will remain intact, the circumstances in which the exemption can be applied will, in essence, be restricted to genuine redundancy situations. This will remain a contentious area on which specialist advice will still be recommended.