HMRC CLARIFIES UPCOMING CHANGES TO TAX TREATMENT OF TERMINATION PAYMENTS

6 April – all change with tax on termination payments

In its February employer bulletin, HMRC has clarified the commencement provisions for the forthcoming changes to the tax treatment of some payments made on termination of employment introduced by the Finance (No 2) Act 2017.  

Currently, payments on termination that are made under a contractual PILON (pay in lieu of notice) clause in an employee’s contract are taxed as earnings, but if there is no PILON an equivalent payment can often be made tax free (up to £30,000) as it is characterised as "damages for breach of contract." 

The changes, which are due to take effect on 6 April 2018, will require employers to treat as earnings any part of a termination award that reflects basic pay for all or part of the employee’s notice period that is not worked, even if there is no PILON clause in the employee’s contract.This part of the award will therefore be subject to tax and national insurance contributions (NICs).  

Any remaining part of the termination payment, typically redundancy or ex-gratia sums, will still benefit from the £30,000 exemption as before. The Government is also proposing that payments over and above the £30,000 threshold which are often free from NIC will become subject to employer NICs, but this revision is not due to come into effect until April 2019.  

The changes will have effect for the tax year 2018-19, which HMRC has now clarified as meaning that they will only apply to payments that are both made in, and relate to termination occurring in, that tax year (ie from 6 April 2018 onwards). So, if you are discussing potential terminations now, it is worth ensuring that the date of any proposed terminations falls before 6 April, if you want a non contractual payment in lieu to benefit from the £30,000 exemption. 

HMRC will be providing full guidance on the changes introduced by the Finance (No 2) Act 2017 in due course.