Termination payments are commonplace and useful to employers when negotiating settlement agreements.  Many people are aware that the first £30,000 of certain termination payments are tax-free for both Income Tax and employer and employees National Insurance Contributions (NIC). However, both the government and HMRC felt there was a loop-hole as to how termination packages were being structured and in 2012 proposed rule changes started to emerge after government consultation, regarding the simplification of the tax rules for termination payments.  

Unsurprisingly, this leads to a change of rules which are anything but simplified and result in increased costs to employers which businesses should be mindful of.

The tax rules for termination payments, specifically what is qualifying and forms part of the £30,000 exemption are detailed and advice should be sought on what makes up a termination package. This blog highlights the 2018 and 2020 changes employers need to be aware of.

From 6 April 2018, new rules came into effect which means that all Payments in Lieu of Notice (PILON), equivalent to the employees unworked period, would be subject to both employee and employer NIC in full as well as Income Tax. The term PILON is in most employment contracts and allows an employer to pay an employee a sum owed for their notice period without the employee having to actually work their full notice period. The reason for the change was that the PILON clause was being stripped from contracts, to enable payments made for periods which employees didn’t work to be covered by the £30,000. By terminating an employee immediately who had no PILON clause in their contract, the payments would no longer be treated as earnings and therefore qualify under the £30,000 exemption.  Both HMRC and the government were concerned that contracts were being structured to manipulate this loop-hole and so the rules were changed.

In addition, two further changes were made in 2018 removing foreign services relief and making the tax exemption for injury to feelings condition a recognised medical condition.

Employers need to be aware of these changes and understand the impact the increased costs to their business this may bring. 

In addition to this, delayed changes are now set to come in from 6 April 2020, that means payments in excess of the £30,000 exemption will attract employers NIC. It is anticipated the additional NIC will be collected in real-time as part of the employers’ payroll. Although the employers NIC treatment of termination payments will change, the existing employee NIC exemption will be retained even if the payment exceeds £30,000. 

In summary, payments made that relate to an unworked period will be fully taxable by both the employee and employer together with employers facing increased costs in relation to NIC on termination payments above the £30,000 exemption. To reduce costs, where possible businesses who have imminent settlement agreements in excess of the £30,000 exemption should look to conclude these before the rules change.

If you feel you may be affected by changes to termination payments and the associated rules then do get in touch with Jennie Brown on jbrown@ellacotts.co.uk or 01536 646000 to arrange a telephone call or meeting to discuss your position.