Incoming changes to the taxation of termination payments


On 10 August 2016, the UK government delivered a report and draft legislation (available here) following its 2015 consultation on the tax/national insurance treatment of termination payments. Effective from April 2018, the regime will be amended with the stated aim of reducing the scope for employer abuse and increasing simplicity, fairness and certainty. In summary:

  • all payments made in lieu of an employee's notice entitlement, whether pursuant to an express PILON clause in an employment contract or not, will be treated as "earnings" rather than a "termination payment" and thus be fully chargeable to income tax and employer/employee national insurance contributions ("NICs");
  • the first £30,000 of any "termination payment" will remain exempt from income tax and all NICs;
  • all payments made to employees which "relate solely" to the termination of their employment will remain totally exempt from employee NICs. However, income tax and employer NICs will become payable on the balance of any termination payment over £30,000;
  • employer NICs will become payable on termination payments above £30,000 to align with rules on income tax;
  • "outdated" foreign service relief will be abolished (except in relation to "seafarers");
  • the tax exemption in respect of termination payments for employee injury or disability will be retained, but clarified so as not to apply in cases of mere "injured feelings" – although recognised psychological injuries or disabilities will still be sufficient to invoke this exemption; and
  • the exemption in respect of certain legal costs will be retained in its entirety, with no cap to be introduced.

The incoming changes are less radical than they could have been but there is little doubt that severance costs will increase overall unless employers respond by applying a corresponding reduction to the termination payments they are willing to offer.

As the draft legislation states, all of an employee's "post-employment notice income" and any "expected bonus income" will be taxable as earnings - removing the possibility of a non-contractual, tax free PILON. In high value cases, the introduction of employer NICs on the balance of termination payments above £30,000 could also lead to a large bill that will need to be factored into future negotiations. The legislative proposals are open for comment until 5 October 2016.

This article is part of our Employment Law Update for September 2016