From 6 April 2018 new provisions will apply to the tax treatment of pay in lieu of notice (PILON) on the termination of employment.

At the moment, the taxation of PILON payments depends on whether there is a contractual PILON in the contract or not. If there is no express, implied or “auto” PILON then the whole of the termination payment can benefit from a £30,000 tax free exemption. Therefore, if the termination payment is under £30,000, the whole payment could potentially be paid tax-free.

For terminations on or after 6 April 2018, this will no longer be the case. Instead, the portion of a termination payment which relates to the basic pay an employee would have earned had the employee worked his or her notice in full should be taxed and subject to NICs (both employer and employee). This is the case irrespective of whether or not there is a contractual PILON in the employee’s contract.

What will employers need to do?

As a result, employers will need to make it clear when making termination payments to separate the payment relating to notice (which must be taxed) and any additional payment. The remaining amount can be treated as compensation benefitting from the £30,000 tax exemption. The terms of settlement agreements should reflect this split.

It is worth noting that statutory redundancy pay will still fall within the £30,000 tax exemption. However, non-statutory redundancy pay will not automatically fall within the exemption.

Implications of getting it wrong

It is important, therefore, that employers get the tax treatment of termination payments in settlement agreements right from the outset. HMRC can recover unpaid tax and NICs, penalties and interest from the employer and employee (but normally choose to pursue the employer rather than the employee). Although it is common for settlement agreements to include a tax indemnity allocating the tax risk to one of the parties (commonly the employee) it is clearly preferable to avoid claiming under an indemnity should HMRC decide that the tax treatment wasn’t correct in the first place.

A 2019 date for your diary…

There is also another related reform which is due to come into force in April 2019. NICs will become payable on all termination payments above £30,000 (they are currently subject to income tax only).

If you wish to discuss anything contained in this article or have any employment-related queries, please do not hesitate to get in touch with any member of our Employment team today.