During the summer the Government has been consulting on draft legislation to change some aspects of the tax and National Insurance treatment of termination payments. Legislation is expected to be included in the Finance Bill next year and will take effect from 6 April 2018. So what is changing and when?
A termination package typically includes a number of elements, for example, salary, holiday pay, compensation for loss of office, pay in lieu of notice, and statutory redundancy pay. Different tax and National Insurance treatments apply to different elements of the package. So, to tax the package as a whole, it is necessary to identify each component part and tax that correctly.
Some payments made on termination are payments of earnings and attract PAYE tax and National Insurance. This is the case, for example, for payments of outstanding salary and for holiday pay.
Other elements of the package are compensation payments designed to compensate the employee for losing his or her job. Redundancy pay and compensation for loss of office fall into this category.
Payments which are taxed as termination payments rather than earnings benefit from a £30,000 tax exemption and are also currently free of National Insurance, even to the extent that they exceed the £30,000 tax-free limit.
Payments in lieu of notice (PILONs) can be tricky. Broadly, a PILON which is contractual or expected is treated as a payment of earnings and is subject to PAYE and NIC without the benefit of the £30,000 exemption. By contrast, a non-contractual PILON is taxed as a termination payment and benefits from the £30,000 exemption.
Proposed new rules April 2018
Although the basic approach will still be to identify the component parts and apply the correct treatment to each part, there are some significant changes.
From 6 April 2018, termination payments in excess of the £30,000 exemption limit will attract employer’s National Insurance contributions. However, as now, no employee National Insurance contributions will be payable.
More fundamentally, all PILONs will be treated as earnings and taxed as such. This means PILONs will no longer benefit from the £30,000 exemption even where the payment is non-contractual and damages in nature. Consequently, all PILONs will be liable to PAYE tax and National Insurance (employer’s and employee’s).
The good news is that the £30,000 exemption will remain at its current level and in its current form, albeit that it will no longer apply to PILONs. For those whose employment has included time spent working overseas, the bad news is that the foreign service relief, which can provide an exemption considerably in excess of £30,000, is to be abolished completely.
If you would like more information about the changes please contact Mark Wildi on 01689 877081.