Tax-free Payments In Lieu Of Notice terminated
Tax-free PILONs terminated
The tax rules governing ‘termination payments’ or Payments in Lieu of Notice (PILONs) have always been complex and an area of contention in some cases. This has particularly been so in recent years, where there has been scope for employers to manipulate the rules by structuring arrangements to include payments that would ordinarily be taxable, in order to minimise the income tax and National Insurance due. One of the main areas of concern has been whether the well-known £30,000 tax-free exemption applies to a payment. However, things are set to change from April 2018, when a series of reforms are brought into play – all designed to make everything clearer and fairer!
As things currently stand, when an employee receives a payment in lieu of notice, it is necessary to look at whether he or she has a contractual right to that payment – in general terms, if a contractual right exists, it will be fully taxable as earnings. It is this ‘contractual right’ element that has provided a degree of scope for manipulating arrangements to take payments outside the taxable earnings boundaries – and in doing so, for potentially escaping the charges to tax and NICs. In an attempt to level up the playing field, from April 2018, all PILONs, rather than just contractual PILONs, will be treated as taxable earnings. Therefore, under the new rules, all employees will pay tax and Class 1 NICs on the amount of basic pay that they would have received if they had worked their notice in full, even if they are not paid a contractual PILON.
This change means that the tax and NICs consequences should be the same for everyone – it will no longer depend on how an employment contract is drafted, or whether payments are structured in some other form, such as damages for example.
Genuine termination payments
Whilst the existing £30,000 income tax exemption for terminations payment remains in place, it should be noted that from April 2018 the National Insurance Contributions rules will become aligned with the tax rules, which means that employer NI contributions will be payable on the elements of the termination payment exceeding £30,000. This could prove costly to some employers and they should be advised accordingly.
Additionally, although the existing £30,000 exemption will remain intact, the circumstances in which the exemption can be applied will, in essence, be restricted to genuine redundancy situations. This means that the whole subject of termination payments is likely to remain a contentious area for tax and NIC purposes, and clients should be recommended to seek prior advice where possible.
As with most anti-avoidance measures, HMRC will be closely monitoring how the reforms are operated. If perceived misuse of the rules becomes apparent, we are likely to see further changes being made. For instance, when the changes were originally announced in the 2017 Spring Budget, the government also advised that a new power will allow the Treasury to move the £30,000 exemption threshold upwards or downwards.