Tax changes to termination payments from April 2018

Currently, employees can receive the first £30,000 of any termination payment free of PAYE and national insurance contributions (NICs). Any payment above this amount is subject to PAYE but not NICs. This rule also applies to pay in lieu of notice (PILON) as long as PILON is not a contractual employment right.

The government announced in this year’s Budget that termination payments which are subject to income tax on any amount in excess of £30,000 would also be subject to employers’ NICs. In response, HM Revenue & Customs has published draft legislation which is expected to apply from April 2018.

The draft legislation contains some significant changes regarding how PAYE and NICs will apply to termination payments. The main changes are:

• All PILON will be treated as earnings and subject to PAYE and NICs regardless of whether or not there is a PILON clause in the employee’s contract of employment.
• In addition to PAYE, termination payments over £30,000 will be subject to employers’ NICs (but not employees’).
• Any termination payment apportioned to “injury to feelings” will not be covered by the general tax exemption for injury payments, except where they relate to a psychiatric or medical injury or a recognised medical condition.

On the plus side, these new rules will eliminate the uncertainty surrounding ‘tax or no tax’ on termination payment, where there is currently conflicting case law.

The down side is that these rules will potentially make terminating employment more expensive for employers.

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