Employment termination – new tax rules for payments in lieu of notice

From 6 April 2018 new rules for the calculating the income tax due on termination payments will be in place. Employers and employees should take note as the new rules may give results they are not expecting.

Until now, contractual payments on the termination of employment, typically a payment in lieu of notice (PILON), have been taxable.

Where an employee is put on garden leave or not allowed to work their notice period, the PILON has been tax-free up to £30,000.

This is all set to change on 6 April with the introduction of the new rules.

From 6 April 2018, employers will need to calculate the amount of pay a departing employee would have received, had they worked their notice period. This sounds simple but is not so when the detailed rules are addressed.

The amount above is termed the post-employment notice pay – the PENP – which will be subject to tax and National Insurance contributions as normal earnings.

Any payment amount in excess of the PENP, and relating solely to the termination of employment, will be subject to the normal termination payment rules where the £30,000 exemption will apply.

Remember too that statutory redundancy pay counts towards this threshold.

The calculations need to exclude holiday pay, termination bonuses and such like which are taxed as normal earnings – it will not be straightforward! Calculating a departing employee’s PENP will be further complicated if the individual has received a large one-off payment in his/her last payment period.

NIC introduced on the excess from April 2019

In addition, from April 2019 employers will also have to pay Class 1A NIC on any excess payment over the above £30,000 threshold. This amount will be payable ‘in year’ rather than after the tax year end as with other Class 1A NIC liabilities.

Employers seeking to agree payments to departing employees will need to review the new rules very carefully.

As with a lot of tax legislation the devil is in the detail. Getting it wrong could mean higher costs for the employer and a reduced net of tax receipt for the ex-employee.

Sadly, whilst there may have been a need to tighten the rules, the complexity of the new rules ensures that PAYE and NIC compliance continues to be an activity fraught with difficulty.

If you think these new rules might affect you or your business, please do get in touch with our expert Tax team at Friend Partnership – we’d be pleased to help you plot your way through the process.

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