The income tax and NIC (National Insurance Contribution) treatment of payments in lieu of notice (PILONs) has once again been re-visited.
The recent case of SCA Packaging Limited (SCA) v HMRC (HM Revenue & Customs) considered the issue of PILONs not specifically referred to in the employment contract. The case determined whether payments made as part of redundancy arrangements in respect of unexpired notice periods, were taxable as earnings or taxable as payments received in consideration of the termination of the employment (and therefore subject to the £30,000 exemption and payable NIC free).
The case concerned two sets of employees who had been made redundant some years earlier ("Office Staff" and "Non-Office Staff").
None of the employees had PILON clauses in their employment contracts. However, in relation to the Non-Office Staff, a Memorandum of Agreement ("Memorandum") had been negotiated between SCA and the relevant trade unions relating to redundancy. The Memorandum recorded that, as part of a redundancy payment, payment "would also be made for any unexpired period of notice as at the date of termination".
It was determined that the Memorandum had been incorporated into the Non-Office Staff's contracts because they were, on or before the start of their employment, provided with a written statement of their terms and conditions of employment which included such Memorandum. The Non Office Staff signed to say that they had received and understood the terms and conditions.
However, the same procedure had not been followed with Office Staff. The Special Commissioner therefore considered whether the Memorandum had been incorporated by "custom and practice". His view was that it had to be clear that the Memorandum had been drawn to the attention of the Office Staff or had been followed without exception for a substantial period. This is because in order to be a custom it must be 'reasonable, certain and notorious'.
The Special Commissioner concluded that, in respect of Non-Office Staff, the wording in the Memorandum was not sufficient to give SCA the right to terminate the contract by paying a PILON. However, if an employee agreed to short notice the clause provided the means of calculation of an entitlement to payment as a result. He determined that if the employee agreed, he would be agreeing to give up his notice rights and not agreeing to terminate the contract. The payment was in return for the modification of the contract rather than its termination (e.g. the redundancy rights in the contract remained in force) and as such, the payment was earnings and fully taxable.
In relation to Office Staff, in order for the PILON to be fully taxable, it must have arisen by reason of "custom or practice" and therefore be incorporated into the employment contract.
On the facts, it was determined that there was insufficient evidence that the one employee (whose facts were considered in detail) had been aware of any custom in respect of the policy in the Memorandum. Therefore, the fact that one employee was not aware of a particular policy seems sufficient for there not to be any custom and practice relating to all other employees of the same class. In these circumstances, the PILON was made in return for cancellation of the contract of employment and so the payment derived from the termination and not the employment (and therefore subject to the £30,000 exemption and payable NIC free).
It is clear from the Special Commissioner's approach that HMRC's current view (see Tax Bulletin 63) which states that where a PILON is paid as an automatic response to a termination it will be taxable as earnings, is too broad and that the facts of the case need to be considered very carefully to determine the nature of the payment.
It is interesting to note that HMRC's view that if a payment is to be compensatory in nature it should be calculated by reference to the principles relating to damages, does not appear to have been considered relevant in determining the nature of the payment.
The decision serves as a timely reminder for employers that the assumption that payments made on termination of employment either under a compromise agreement or made on an "ex-gratia" basis are automatically tax-free up to £30,000 is often misplaced. There is nearly always a need to consider whether such payments can be derived from the contract of employment, rather than in compensation for loss of office. Employers may also wish to review any redundancy policies and other documents which, in their view, do not form part of the employment contract to ensure that no elements of the policy etc could be taken to vary the employment contract so as to render a PILON taxable.