Complex and Frequently Manipulated - Reform of the Tax Rules Concerning Termination Payments

The response includes draft legislation due to come into force in April 2018. The government's stated objective is to simplify the rules and avoid manipulation of them by employees and employers.

So if things remain the same at the end of the consultation process, what's changing?

The government's current position is that from April 2018:

The Distinction Between Contractual and Non-Contractual Payments in Lieu of Notice (PILON) will be Removed.

• This means that all PILONs will be subject to tax and NICs as earnings. The distinction between contractual and non-contractual termination payments will be retained.
• Employers will no longer have the option of making a 'damages' payment in respect of an employee's notice period where there is no PILON clause, which can be a useful negotiation tool in settlement discussions.

All Other Post-Employment Payments which would have been Treated as Earnings if the Employee had Worked their Notice Period will be Subject to Tax and Class 1 NICs.

• The government intends that the employee be treated as having worked their notice, regardless of whether that actually happens.
• This will include accounting for the cash value of benefits in kind (e.g. company car, gym membership) and any bonuses which would have been received during the notice period.
• The draft legislation defines 'bonus' widely as 'commission, incentive or anything similar'.

The £30,000 Exemption for Payments Relating Directly to the Termination of Employment will be Retained.

The Rules for Income Tax and Employer NICs will be Aligned. 

• This will mean that employer NICs are now payable on termination payments above £30,000.
• However, there will be no change to employee NICs so an unlimited employee NIC exemption will continue in respect of termination payments.

The Legislation will Confirm that the Exemption which is Available for Payments made in respect of 'Disability or Injury' Do not Extend to Injured Feelings.

• For the tax exemption to apply, an injury or disability of a physical or psychological nature that is sufficient to prevent the employee from performing their role will be required.

Foreign Service Relief will be Abolished, Except in Relation to Seafarers.
 

What's does it all mean?

In its response, the government heavily focuses on the desire to simplify the rules, make them fairer and prevent manipulation. It remains to be seen whether the reforms will meet these stated objectives, and whether there will be other ramifications once the consultation is over.

It is possible, as envisaged in the response, that the additional cost of employer NICs will mean that payments over £30,000 become less common. In addition, as there will no longer be any distinction between contractual and non-contractual PILONs, there may be no benefit in leaving PILON clauses out of contracts of employment.

In respect of the treatment of bonuses, we note some scope for uncertainty about what would have been earned during the notice period. It is possible that the reforms will necessitate changes to bonus and incentive scheme wording but this will only become clear when the consultation process is over and the final draft of the regulations is available.

The government has invited further input into the consultation and draft legislation. The consultation closes on 5 October 2016.

For more information, please contact Charlotte Williams in our Employment Law team on 0117 314 5219.