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How should termination payments be taxed from April 2018?

Since we wrote our blog on the proposed changes to the taxation of termination payments, the government has published updated draft legislation. Some comments raised during the consultation process have been taken on board and, therefore, the new proposals are slightly different from what was originally envisaged.

From April 2018:

  • All payments in lieu of notice will be treated as earnings and subject to income tax, employer NICs and employee NICs. Currently, if you have a contractual right to make a PILON, that payment is subject to tax and NICs. If you don’t have a contractual right to make a PILON, any payment made in respect of an employee’s notice entitlement is generally regarded as ‘damages for breach of contract’ and the first £30,000 can be paid tax-free (and no NICs are due).
  • If an employee doesn’t work their notice, they will still need to pay tax and NICs on any payment which corresponds to the earnings they would have received if they had worked their notice. This post-employment notice income is to be calculated on the basis of basic pay only, disregarding overtime, bonus, commission etc. The concept of bonus income referred to in the earlier draft regulations has been dropped.
  • Currently, the first £30,000 of a non-contractual termination payment is tax-free, with any balance over £30,000 subject to tax. No employer or employee NICs are due. The £30,000 limit is to remain, but from April 2018, employer NICs will be due on any balance over £30,000. There will be no change as regards employee NICs.
  • There has been confusion as to whether termination payments relating to ‘injury to feelings’ are exempt from tax (under an exemption for payments relating to disability or injury). From April 2018, the government has clarified that payments for injury to feelings will only be exempt if they relate to a psychiatric injury or other recognised medical condition. Note that injury to feelings payments where the discrimination is not related to termination can be paid tax-free – this is not changing.
  • Foreign service relief will be abolished (except in relation to seafarers). However, a new provision has been inserted to ensure that termination payments are not taxable unless there is a territorial connection with the UK (through the employee’s UK residence status or the duties of the employment being performed in the UK.)
  • The Treasury will have a power to vary the £30,000 threshold by regulations.

One thing to take away from these changes is that termination payments will often become more expensive for employesr, with the employee receiving a smaller net payment as a result.

A consultation on the amended regulations is now taking place with comments due by 1 February. We will provide guidance on what these changes mean in practice after the consultation process is complete and the proposals are finalised.

In the meantime, if you would like advice on any of the issues raised, please get in touch with your usual Brodies’ contact.


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