The government has unveiled its draft legislation, setting out
how it plans to simplify and tighten the rules on the taxation of
In the government's March 2016 Budget, it announced its
proposals as to how it was going address the taxation of
termination payments. The proposals followed a consultation
launched in 2015. The government has now published its response to
that consultation as well as the draft legislation to deliver the
proposed changes. The draft regulations will result in increased
costs for employers, although the new regime will be somewhat less
confusing that the current regime. Overall, employers will be
pleased that the £30,000 tax free threshold on termination
payments will remain and that the Government has dropped its
proposals to have a lower, variable threshold.
The changes are expected to come into force in April 2018
after another period of public consultation on the draft
legislation, which will close on 5 October 2016.
The current rules
A payment made on termination of employment is often made
up of several different elements which may include, for example, a
statutory redundancy payment, any enhanced payment, a payment in
lieu of notice (PILON) and an ex gratia payment to cover any
potential claims. Currently PILON payments that are either provided
for in the contract of employment, or which are paid
"automatically" on the termination of employment, are
fully taxable, whilst other elements, such as compensation for
breach of contract, ex gratia payments, and redundancy payments are
tax free up to an aggregate amount of £30,000 (once over that
amount such payments are subject to income tax, but remain free of
A report by the Office of Tax Simplification in 2014 found
that there is confusion around these rules (which it called
"complex") – although the reality is that they are
well understood by HR departments.
The Government's new draft regulations
Following an initial public consultation which closed in
October 2015, the Government has published new draft regulations
providing that -
The first £30,000 of a
termination payment will remain exempt from income tax and employer
and employee NICs
&Co comment – employers will
welcome the fact that there is to be no reduction in the current
£30,000 threshold. However, as will be seen below, payments
which fall to be classified as "termination payments" are
narrower in scope.
Termination payments over
£30,000 will continue to be subject to income tax, but will
now also be subject to employer NICs (but not employee NICs)
&Co comment - this was first
announced in the March 2016 budget. It always seemed odd that
although income tax became payable on amounts over £30,000,
national insurance contributions did not. Unfortunately this change
will lead to an increased cost for employers, with employers'
NICs being at 13.8%, but we can't see this having a huge impact
on the number of settlements because the very important tax break
for the employee (the first £30,000) will remain - and that
is to be welcomed.
Redundancy payments, ex-gratia
compensation payments and unfair dismissal awards will continue to
count as termination payments and so will be taxable only to the
extent they exceed £30,000
However, the current
distinction between contractual and non-contractual PILONs will be
removed so that all payments which are paid in lieu of notice will
be fully taxable. It is proposed that any amount received as pay in
lieu of notice (PILON) and any other payment (including benefits in
kind) that the employee receives, or would have received during
their notice period (whether or not they work for it) will be fully
taxable as general earnings, and subject to employer and employee
Clyde & Co
comment – Currently, a PILON which is paid under the
terms of an employment contract is fully taxable, whereas the
£30,000 exemption can be used for damages paid in lieu of a
notice period if the contract has no PILON clause and the employer
doesn't pay the amount "automatically". This strange
differential has now been removed, so all amounts paid in relation
to a notice period will be taxable.
Foreign service relief will be
removed except in relation to seafarers
The new rules will clarify that
amounts paid in relation to injury to feelings (which is an area
which has been historically used to pay damages tax free in
discrimination cases) will no longer be tax free – unless
there is either psychiatric injury or another recognised medical
condition which has resulted from the treatment in question
Everyone has sympathy for employees who are genuinely unwell. When advising employers about employees suffering from stress, various medical conditions and resultant absence, it is these words that come up again and again.
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