The rules on the tax and National Insurance treatment of termination payments is changing from 6th April 2018.
Payments made on the termination of an employment are treated differently depending on whether the payment is a payment of earnings, such as normal wages and salary, or a compensation payment, such as damages for loss of office. Payments taxed as compensation payments benefit from a £30,000 tax-free exemption and are only taxable to the extent that they exceed £30,000.
It is not always easy to determine whether a payment is one of earnings or a compensation payment benefitting from the £30,000 exemption. In particular, payments referred to as ‘payments in lieu of notice (PILON)’ cause difficulty in practice, not least because the term is used to describe payments that differ in nature. Under the current rules, PILON which the employee is contractually entitled to receive, or which the employee has an expectation of receiving are taxed as earnings and do not benefit from the £30,000 exemption. By contrast, payments for which there is no contractual entitlement or expectation and which take the form of damages for the failure to give proper notice, benefit from the £30,000 exemption.
The treatments of PILON is to change from 6th April 2018 onwards. From that date, the payment is compared to the pay that the employee would have received had the employment continued throughout the notice period. Where the termination payment is not more than the pay that the employee would have received in the notice period had the employment not been terminated, it is taxable in full. Any excess, over what would have been payable had the employment continued, is treated as a compensation payment and will benefit from the £30,000 exemption.
From 6th April 2018 Employer National Insurance contributions will be payable on compensation payments made on the termination of employment to the extent that they exceed the £30,000 tax-free threshold (payments will remain free of employee’s NI).
Please call us on 01275 852255 to discuss the structuring of tax-efficient termination packages.