UK: Taxation Of Termination Payments – New Government Proposal Will Erode The Scope Of The £30,000 Exemption

In July 2015, the government published a consultation on proposals to reform the tax treatment of termination payments, which was widely discussed with stakeholders. Nine months after the end of that consultation, the government has published a revised proposal, together with draft legislation. Stakeholders are invited to comment by 5 October 2016. It is intended that the new rules will be implemented with effect from April 2018.

The new proposal includes a number of positive aspects, including that the tax exemption will not be confined to termination payments made in a redundancy situation (as had been suggested previously), that the current level of the tax free threshold (£30,000) will be maintained (at least for the time being) and that most of the current reliefs applicable to termination payments will also be maintained.

However, it is also clear that the proposed changes will erode the concept of termination payments that can potentially benefit from the £30,000 exemption.

The main features of the revised proposal

The concept of termination payments is retained in that any payment made to an employee solely in relation to a termination of employment will continue to benefit from a tax free threshold of £30,000 and will continue to be free from employee's national insurance contributions (NICs). However, termination payments in excess of £30,000 will be subject to income tax (as previously) and also to employer's NICs (in contrast to the current position where termination payments are fully exempt from NICs).

While the distinction between contractual payments and non-contractual payments will be retained in principle, the draft legislation provides that any payment that the employee would have received if they had worked their contractual notice period will be subject to income tax and NICs – regardless of when the employee actually leaves or whether the employment contract restricts entitlement in a termination situation. Further, all payments in lieu of notice (PILONs), whether contractual or non-contractual, will be subject to income tax and NICs in full. The draft legislation achieves this by providing that the relevant payments will fall within a defined type of payment which is subject to income tax and NICs, and it is therefore irrelevant how any such payments are 'labelled' in a settlement agreement.

Statutory redundancy payments will continue to benefit from the £30,000 exemption.

Existing reliefs which exempt termination payments in excess of £30,000 from income tax will be largely maintained, with the following modifications:

  • It will be clarified that the exemption for termination payments made in respect of death, disability or injury will not apply in cases of injured feelings.
  • Foreign service relief will be abolished (other than for seafarers).

The draft legislation erodes the scope of the £30,000 exemption by cutting across the terms of the contract of employment, in particular with regard to bonus payments

The principles set out above make for an uneasy relationship between the legislative provisions and the terms set out in a contract of employment. Essentially, the draft legislation requires employers to consider what the employee would have been entitled to under his contract if he had worked his entire contractual notice period, but without having regard to the termination itself and any provisions restricting entitlement in the event of a termination.

This is best illustrated by worked examples:

Example 1 – PILONs: An employee is entitled to gross salary of £48,000 per year and a minimum of six months' notice. The contract does not provide for a PILON, and the employment is terminated without notice. On termination the employee receives a payment of £60,000.

Tax treatment under the proposed new rules: If the employee had worked during his contractual six months' notice period, he would have received salary of £24,000. Accordingly, £24,000 of the £60,000 termination payment will be subject to income tax and NICs. The remaining £36,000 will be taxed as a termination payment, i.e., the first £30,000 will be exempt from income tax and NICs, and the balance of £6,000 will be subject to income tax and employer's NICs (but not employee's NICs).

Comparison with current rules: Under current rules, it would be arguable that the entire payment should be a termination payment which would be subject to income tax only above the £30,000 exemption, and would be exempt from NICs, on the basis that there is no contractual PILON (assuming that the employer does not operate a custom or practice of making PILONs and that the employee does not have a reasonable expectation to receive a PILON).

Example 2 – bonus payments: An employee is entitled to gross salary of £48,000 per year and a minimum of six months' notice. The employee is also entitled to participate in a bonus scheme by reference to the employer company's results in the calendar year. Where a bonus is earned, it is paid on 30 April following the calendar year in respect of which the bonus was earned, and the contract further provides that the bonus is only payable if the employee is employed on the bonus payment date.

The employee is dismissed without notice on 30 September and receives a payment of £72,000 on termination. But for the dismissal, he would have been reasonably expected to receive a bonus of £12,000 based on the employer company's results in the calendar year during which the dismissal took place.

Tax treatment under the proposed new rules: As before, there will be a taxable PILON of £24,000. Also, a further £12,000 will be subject to income tax and NICs as earnings by reference to the bonus that the employee would have been expected to receive (despite the fact that he did not actually qualify for a bonus under the terms of the bonus scheme). The reasoning is that if the employee had worked his six months' notice period, this would have taken him beyond the end of the calendar year on which the bonus entitlement is based, and he would have received the bonus but for the dismissal, which prevented the employee from being employed on the bonus payment date (30 April). The remaining £36,000 will be taxed as a termination payment as set out in Example 1.

Comparison with current rules: Under current rules, it would be arguable that the £12,000 (which under the proposed new rules will be taxed as earnings subject to income tax and NICs by reference to the bonus) should instead be treated as forming part of the termination payment and therefore be exempt from NICs, on the basis that the employee has no contractual entitlement to receive the bonus (assuming that the employer does not operate a custom or practice of paying the bonus anyway and that the employee does not have a reasonable expectation to receive the bonus).

As is clear from the above examples, the revised rules will push more elements of a termination package into the category of 'contractual payments', which are earnings fully subject to income tax and NICs. In our view, this is far removed from the original stated purpose of this reform, which was a drive for simplification. Rather than simplifying matters for employers, the new rules will continue to be difficult to apply without specialist legal advice.

Opportunity to respond to the consultation

The current consultation relates to the draft legislation in the first instance, rather than to the principles behind it (which the government will argue were the subject of the previous consultation). In that spirit, the questions asked in the current consultation largely relate to detail in the drafting (which is beyond the scope of this alert).

However, there is still an opportunity to provide a general response and comment on the feasibility of applying the new rules. We are considering putting together a response and, for that purpose, would very much appreciate hearing your views on the following points:

  1. Do you consider that the new rules (if implemented in their current form) will simplify the tax treatment of termination payments and will provide sufficient clarity for employers to apply them consistently and correctly?
  2. Do you anticipate any particular difficulties in operating the new rules, including from the perspective of payroll managers and with regard to the timing of termination payments?
  3. Do you anticipate that the new rules could have an adverse effect on negotiations with departing employees?

If you would like to review the current consultation and consider the draft legislation in detail, you can access it here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.