A year ago, in summer 2015, HMRC consulted on simplifying the income tax and Class 1 NICs of termination payments. On 10 August 2016, HMRC published its response to the consultation and published draft legislation for final consultation. Responses are required by 5 October 2016.
From April 2018, HMRC is proposing to make the following changes.
Pay in lieu of notice payments (PILON)
HMRC consider there has been too much confusion concerning whether a PILON is contractual (taxable) or not (non-taxable as long as it and any other non-taxable payments do not exceed £30,000). Therefore, from 2018 all PILON payments will be subject to PAYE income tax and Class 1 primary and secondary NICs.
Other termination payments
HMRC will tax and subject to Class 1 primary and secondary NICs any payment that the employee would have received if they had worked their notice period, even if the employee is asked to leave employment immediately or part way through their notice period.
Payments relating directly to the termination of the employment (like statutory and enhanced redundancy pay and compensation for loss of office) will have a £30,000 income tax and employer secondary NICs exemption. There will be continue to be an unlimited employee primary NICs exemption on termination payments.
Exempt termination payments
There are various exemptions, reliefs and reductions that currently apply to termination payments in addition to the £30,000 threshold. For these exemptions to apply, the payment must be connected to the termination itself and not be contractual or salary.
If the conditions of the exemption, etc. are met then there is no income tax liability even on payments over £30,000.
Currently exempt termination payments include payments made:
- Because of the death, disability or injury* of the employee (will remain);
- Under a tax exempt pensions scheme (will remain);
- To a registered pension scheme (will remain);
- For liabilities and indemnity insurance (will remain);
- To HM Armed Forces (will remain);
- By a foreign government (will remain);
- Where the employee has a certain type of foreign service (will be amended); or
- In respect of certain legal costs.
* As respondents to the consultation pointed out, there is potential for the use of the exemption for injury to grow if it includes injured feelings. Recent divergent judicial decisions on this issue mean that the government has decided to make an amendment to clarify that the exemption does not apply in cases of injured feelings. This reflects what HMRC considers is the correct interpretation of the existing legislation. In order for the exemption to apply there must be an injury or disability of a physical or psychological nature that is sufficient to cause the employee to be unable to perform his or her job properly.
Class 1 NICs changes
When it comes to determining whether a termination payment is taxable or not, employers will need to refer (as they do now) to the employee’s underlying employment contract and other terms and conditions. Any payment that covers part of the existing contractual entitlement, including the notice period even if the employee does not work it, will be taxed and subject to Class 1 primary and secondary NICs as earnings.
Any payment relating directly to the termination of the employment that is non-contractual will be taxed and subject to employer NICs on any amount that exceeds the £30,000 threshold. There will continue to be an unlimited employee NICs exemption on termination payments.