Changes to the taxation of termination payments
All PILONs will be taxed from April 2018, but crucially the Government has decided to retain the £30k exemption for other termination payments.
The Government has finally published its Response to the Consultation on the Simplification of the taxation and National Insurance treatment of termination payments launched last summer. In its Response the Government confirms that all Payments in Lieu of Notice (PILONs) will become subject to tax and National Insurance Contributions, regardless of whether or not a contract of employment gives the right to pay in lieu of notice, from April 2018.
As previously announced in the Budget in March this year, employer's National Insurance Contributions will also become payable on termination payments above £30,000 that are subject to income tax. In addition, the Foreign Service exemption will be removed, and there will be clarification over the use of the exemption for death, disability and injury. The Government has also issued a consultation on limiting the range of benefits in kind that attract tax and NIC advantages as part of a salary sacrifice arrangement, although key benefits are protected.
The outcome of the Consultation is significant for employers because essentially the Government has backed down on many of its original proposals. Blake Morgan responded to the Consultation last year and you can view our response here. The original proposals were far-reaching, looking at removing all distinctions between contractual termination payments (which are taxable) and non-contractual termination payments (which may currently benefit from the £30,000 tax exemption), but replacing this with a significantly reduced exemption linked to an employee's length of service and only applicable in limited termination scenarios, such as redundancy.
In our response, Blake Morgan resisted many of the Government's proposals. It was clear that in many ways the proposals had not been properly thought through because the Government's response was expected by the Autumn Statement in November 2015, but HMRC wrote to us and the other respondents saying that "the responses have helped to highlight the complexities of this area" and that the Government would take more time to consider the issues.
We are pleased to see that the Government has now taken on board many of the objections put by us and others and that the outcome is not nearly as radical as it could have been. The taxation of all PILONs is disappointing and may well result in employees losing out, but it is not entirely surprising. It may have limited impact, as it was noted in the consultation process that contractual clauses allowing for PILONs are more and more common (such clauses are often included to ensure there is no breach of contract when making a PILON and so ensure that restrictive covenants remain in force). However, importantly the general distinction between contractual payments made on termination (such as holiday pay) and other non-contractual payments has been retained. Apart from PILONs, those payments on termination that are not normally payable under the contract (such as genuine compensation payments for loss of employment) will continue to benefit from the £30,000 tax exemption.
The payment of employer NICs, from April 2018, on all termination payments above the £30,000 exemption was also announced in the Budget earlier this year. The Government has confirmed that this does not affect employee NICs, and that there will continue to be an unlimited employee NICs exemption on termination payments.
Foreign Service Relief, which provides a tax exemption for employees who have worked outside the UK for particularly long periods, is to be removed. The current tax exemption for death, disability and injury will be retained but it will be made clear that it cannot be used for injury to feelings. Importantly, the current exemption from taxation of certain legal costs (for example when obtaining independent advice on a settlement agreement) is to be retained. Because the existing exemption of up to £30,000 is being retained, there will not be an additional/separate exemption for unfair dismissal or discrimination compensation.
The Response is accompanied by a further consultation on draft legislation which sets out that any contractual payments and PILONs will be taxed first. PILONS will be assessed on the basis of the value of earnings (including salary, benefits in kind and bonuses) averaged over a 12 week period and calculated according to the notice period the employee would have worked. It also contains anti-avoidance provisions and specifically states that statutory redundancy payments or awards for unfair dismissal are within the £30,000 exemption. Interestingly the draft legislation does contain a power to vary the level of the £30,000 exemption in the future. Following consultation on the draft legislation, which closes on 5 October 2016, it is intended that the provisions will be included in the Finance Bill 2017.
The further consultation has been issued alongside a number of other consultations including one on limiting the range of benefits in kind that attract tax and NIC advantages as part of a salary sacrifice arrangement. However, the Government has confirmed that employee contributions to employer-provided pensions, employer-provided pension advice, employer-supported childcare and provision of workplace nurseries and cycles and cyclist’s safety equipment provided under the cycle to work scheme will remain unaffected.