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Changes to the way that termination payments are taxed came into force on 6 April 2018, so if you are already negotiating settlements you should be aware that any payments will fall under the new regime.
Payments in Lieu of Notice (PILON)
Previously, if an employee was paid in lieu of working their notice, the PILON was treated as taxable earnings and subject to tax and national insurance where there was a contractual right. Where there was no contractual right for the employer to make such a payment, it could usually be paid without deduction of tax, if it came in under the £30,000 tax exemption. Now, PILONs are treated as earnings and subject to tax and class 1 NICs, regardless of whether there is a contractual right in place or not.
Calculating the taxable PILON
This is calculated by taking the basic earnings in the last pay period when the employee worked and multiplying this amount by the length of the notice period not worked. This calculated amount is called the Post Employment Notice Pay (PENP). If the PENP is less than the total termination payment, then an amount equal to the calculated PENP is treated as earnings and should be taxed accordingly (including being subject to employers and employees NI). The rest of the termination payment (above the PENP level) is treated as non-taxable up to the £30,000 exemption and taxed on amounts above.
If the termination payment is less than the calculated PENP, then all of the payment is taxed as earnings. Where any part of the non-PILON termination payment exceeds £30,000 it will be subject to income tax (as is the current position) and, from April 2019, it will also be subject to employer NICs (Class 1 A NICs).
It should be noted that statutory redundancy payments fall under the other earnings rules and are therefore subject to the £30,000 exemption. Care should be taken if relying on this exemption that payments are statutory and not non-statutory.
Employees working overseas
Another change that also came into force on 6 April 2018 affects employees who have spent part of their service with the employer overseas. Previously, they were exempted from tax on a proportion of their termination payment, but this tax exemption has been withdrawn for the majority of UK resident employees.
With tax and NICs now arising on previously “tax free” sums, the ex-employee will be financially worse off than under the old regime, especially if they assume that the £30,000 exemption is available to all of the termination payment. As a result, they may look to their former employer to compensate them on a “post tax and NIC” basis.
Some payments and benefits will remain – and can be paid – tax free, such as outplacement fees and therefore advice should be taken when negotiating termination packages.
For further help and guidance on the issues mentioned above, please get in touch with our tax specialist Fiona Phillips by emailing firstname.lastname@example.org or speak to the team today by calling 01482 325242.