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Reform of the Tax Rules Concerning Termination Payments - what is changing?

on Thursday, 15 September 2016.

The government has recently published its response to the consultation regarding the treatment of income tax and National Insurance contributions on termination payments

The response includes draft legislation due to come into force in April 2018. The government stated that the 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 will change? As it stands, from April 2018:

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

  • 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 is 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 and any bonuses (defined in the draft legislation) which would have been received during the notice period.

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 become payable on termination payments above £30,000.
  • However, there will be no change to employee NICs so an unlimited employee NIC exemption will continue.

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.

What 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.

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 Independent Schools team on 0117 314 5219.

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