The tax treatment of payments in lieu of notice paid on termination of employment“PILONs” has changed from 6 April 2018. Under the old rules pre 6 April , PILONs are subject to tax and national insurance contribution deductions if they are contractual. Such payments are, however, payable tax-free if they are non-contractual and therefore essentially being paid as damages for loss of notice and breach of contract.
However, from 6 April 2018, all PILONS will be treated as taxable “earnings”, irrespective of whether they are contractual or non-contractual, and will be subject to tax and national insurance contributions. Employers must treat the proportion of a termination payment, which reflects basic pay for any part of a notice period that is not served, as earnings subject to tax and national insurance contributions.
Normal termination payments will continue to benefit from the £30,000 tax exemption, but the new category referred to as “post-employment notice pay” (PENP) will be excluded from the exemption. This will involve identifying any notice payments that the employee would have received if they had worked their notice period (irrespective of whether there is a PILON clause in the contract of employment or not), as these will be taxable. HMRC will assume that any termination payment will include post-employment notice pay if the employee is not required to work their full notice (either contractual or statutory). This is calculated as follows:
BP = “basic pay” in the pay period prior to the date on which notice is given, or, if no notice is given, the termination date. Basic pay excludes benefits, bonuses, commission, allowances, share options/awards but, if the employee participates in a salary sacrifice arrangement, pre-salary sacrifice salary must be used.
D = the number of days in the post-employment notice period. The post-employment notice period is the period from the employee’s actual termination date to the earliest date on which the employment could have terminated.
P = the number of days in the pay period prior to the earlier of the termination date or the date notice is given (or, where under the employment contract the minimum notice is a number of whole months).
T = amounts paid on termination (other than holiday pay and termination bonuses) that are already taxable as earnings (e.g. a contractual PILON).
What do employers need to do now?
For any termination payments made to employees from 6 April 2018, employers will need to ensure such payments are taxed correctly under the new regime. The new rules will generally cost the employer and employee more, with additional charges to income tax and NICs. Employers may also wish to consider amending the terms of any standard employment contract to include a PILON clause, as the primary reason for not including such a clause (i.e. to get a tax advantage for payments made on termination) will no longer be applicable. Instead, an employer can take advantage of using a PILON clause to potentially terminate the employment contract without having to allow the employee to work out their notice. Terminating without full notice may otherwise put the employer in breach of contract meaning any post-termination restrictions which might otherwise be relied on may be ineffective.
Other changes to NIC
From 6 April 2019, HMRC have changed the rules for tax and employers NIC making an employer liable to pay NIC’s on termination payments they make to employees. An employer will be required to pay NIC on any part of a termination payment that exceeds the £30,000 threshold. It is anticipated that this will be collected in “real time” as part of the employers standard weekly or monthly payroll returns and remittances to HMRC.