Termination Payments – new rules
Following much criticism of the current taxation provisions for termination packages, the government has published a response to a consultation that took place in July 2015, clarifying its proposals for reform and setting out draft legislation. The government’s aim is to have revised provisions in place by April 2018, with a view to simplification and removing unfairness from the current system..
Under the current law, payments and benefits provided to an employee “directly or indirectly in consideration or in consequence of, or otherwise in connection with” the termination of their employment can be paid free from National Insurance contributions and will only be subject to income tax to the extent that they exceed £30,000.
While this may sound like a relatively straightforward exemption, payments and benefits provided to employees on termination can and often do take a number of different forms meaning that it can be difficult in practice to establish whether the payments fall within the scope of the exemption.
- All payments in lieu of notice (“PILONs”) will be subject to tax and NI (both employers’ and employees’) in the same way as regular salary;
- All other post-employment payments made to employees, which would have been treated as earnings if the employee had worked their notice period, will be liable to tax and Class 1 NI (both employers’ and employees’); and
- Payments relating directly to the termination of the employment will be tax and NI free up to £30,000 (as is currently the case), but any amount paid in excess will be liable to tax and employers’ NI, although employees’ NI will not need to be deducted.
The main repercussion of these changes for employers will be the drafting of employment contracts. PILON clauses will need to be considered differently. Currently employers face the predicament of whether or not to include a contractual PILON for employees who are in particularly senior or commercially-sensitive roles. Having a PILON clause allows employees a quick removal from the business without breaching contracts and endangering post-termination restrictions. However, they automatically attract tax.
The new provisions will provide no tax advantage in excluding PILON clauses and, as such, they should become standard bearing in mind that there will no longer be any advantage in not having a PILON clause in an employment contract. Indeed, in order to minimise the risks of breaching employment contracts through making PILON payments in the absence of an express clause permitting this, we would recommend that PILON clauses become included as standard if and when the new law comes into effect.
Employers will need to consider what they include in their employment contracts and what they can offer employees by way of ex-gratia payments, as they will need to account for the additional tax burden.