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Accountancy  •  Business Services  •  Business Tax  •  HMRC  •  Personal tax  •  Small Business

New rules make employee termination payments more costly

By RJP LLP on 26 April, 2018

There are new rules in place, which became effective at the start of the current tax year, and which impact employers who make termination payments to employees. The actual legislation is complex, but it essentially means the following change for employers:

  • Where an employee’s employment terminates after 5 April 2018, and they receive a payment after that date, the basic salary that they would have received for any period of unworked notice is subject to income tax and national insurance contributions in full. This is irrespective of whether there is a payment in lieu of notice (‘PILON’) clause in their contract of employment.

This change has come into effect because HMRC believed that the existing rules for taxation of termination payments were overly complex, and the exemptions available incentivised employers to manipulate the rules and structure arrangements to include payments that would otherwise be subject to income tax and national insurance contributions. We believe these new rules are actually even more complicated, but since they are now operational, employers should understand the implications.

Effective from 6 April 2018, all PILONs (not just contractual PILONs), are classified as taxable earnings. This means 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. It means that the tax and NIC consequences are the same for every employee and are no longer dependent on how the employment contract is drafted, or whether payments are structured in some other form, such as damages.

The £30,000 income tax exemption is retained for all other qualifying payments, and employees will also continue to benefit from an unlimited employee NIC exemption for other payments associated with the termination of employment. Employers will however no longer benefit from NIC exemptions on payments above £30,000.

Although it adds complexity and means that some individuals will face a higher tax liability, it does appear to be a fairer system to ensure everyone is treated in the same way for tax purposes.

 

How will these new rules affect employers?

You will need to calculate the post-employment notice pay (‘PENP’) for each employee whose employment is being terminated, whether the employment contract contains a PILON clause or not.

Paying a non-contractual PILON will be more expensive for both employer and employee. This is because the employer will have to pay employer NICs at 13.8% on the PENP and the employee will have to pay income tax and employee NICs on the PENP, whereas this would previously have been tax-free.

There are wide-ranging anti-avoidance provisions in place for these new rules, so we recommend all employers take specialist advice if they are uncertain or have any concerns.

For more information please contact us at partners@rjp.co.uk.

 

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