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Taxation of Termination Payments From April 2018

Taxation of Termination Payments From April 2018

From 6 April 2018, the way that termination payments are to be taxed is changing.

The change will apply where both the employment ended, and the termination payment was made, on or after 6 April 2018.

In short, from that date onwards, if a payment is made to an employee upon the termination of their employment and the employee has not worked their full notice period, a “slice” of the amount paid will be regarded as payment in lieu of notice (PILON) and be subject to tax and NICs. Depending on the size of the termination payment, this may render the whole amount subject to such deductions.

This, in itself, is not a departure from previous practice. However, importantly, whether there is a contractual entitlement to a PILON is now no longer relevant. Rather all PILONs will be taxable. This does represent a change from previous practice and seeks to eradicate the grey areas surrounding when non-contractual PILONs could be made tax free. Unfortunately, this means that the new legislation will effectively prevent employers being able to use the possibility of non-contractual PILONs being paid tax-free as a bargaining chip as part of exit discussions.

Furthermore, there is now a specific – more complex – formula, set out in the legislation, to be used for calculating the “slice” attributable to PILON – referred to as the “post-employment notice pay” or “PENP” for short.

What does this mean in practice?

Employers will now need to give due consideration to the new regime when making payments upon termination, given that the changes will, undoubtedly, affect the sum that an employee will actually walk away with.

From a practical point of view, care should be taken that no representations are made to an employee regarding the taxable status of a termination payment, unless an employer is clear that the amount will fall outwith the new rules.

Furthermore, consideration should be had to make sure the PENP is calculated correctly. The reason why it is in the employer’s interests to ensure the correct amount of tax is paid is two-fold.

Firstly, HMRC can recover unpaid tax and NICs, penalties and interest from the employer. Often this will be their preferred route, rather than recovering sums due from the employee. It can then be very difficult for an employer to recover from the employee tax paid on their behalf, even in circumstances where a tax indemnity has been used (for example, in a settlement agreement).

Secondly, the stakes of intentionally paying the wrong tax are higher now as a result of the introduction of the Criminal Finances Act 2017 last year. This introduced a new corporate criminal offence of failure to prevent the facilitation of tax evasion, which is punishable by an unlimited fine, amongst other sanctions. Arguably paying an employee a PILON, without making the necessary deductions for tax, could bring an employer within the scope of this legislation.

HMRC’s full guidance on the corporate criminal offence can be accessed here.

If you have any questions on the changes to the taxation of termination payments, or the corporate criminal offence, please speak with your usual employment or tax team contact.

Kerry Norval
Associate, Employment

Ronnie Brown
Partner and Head of Tax

LChalmers