Last summer, the government consulted on ways to simplify the tax and National Insurance contributions (NICs) treatment of termination payments. Continuing to provide support for employees who lose their jobs was identified as a key focus. The government then confirmed in the Budget 2016 that it did intend to make changes to the taxation of termination payments. The government has now published its response to the consultation, which sets out its proposed changes, and invites further consultation on the draft legislation to implement them.
The government has clarified its position in four key areas – most of which we knew already from previous announcements, but some that are new (and welcome) confirmations. The changes are expected to be included in Finance Bill 2017, taking effect from April 2018.
- £30,000 tax-free termination payment exemption unchanged. Previous announcements had hinted that the government might reduce or abolish the £30,000 tax-free exemption altogether. The tax-free exemption applies to non-contractual payments made in connection with a termination of employment. The response paper confirms that the exemption limit, in place since 1988, will remain. This is good news for leavers, who can continue to receive the first £30,000 of a termination payment tax free. As now, employee NICs will not be payable on termination payments.
- Employer NICs payable above £30,000. Employer NICs will now be payable on termination payments to the extent they exceed £30,000. This will considerably increase costs for employers where departing employees receive substantial termination payments.
- Payments in lieu of notice (PILONs) and post-employment payments. The taxation of PILONs has been under government scrutiny for some time, due to the unclear distinction between contractual PILONs (broadly speaking treated as earnings and subject to income tax and NICs) and non-contractual PILONs (often treated as termination payments so, under current rules, subject to income tax only above £30,000 and not subject to NICs). To end this confusion, all PILONs will be treated as earnings and, as a result, subject to income tax and NICs. This may lead some employers who previously omitted PILON clauses from their contracts in order to benefit from the £30,000 exemption to consider including them in the future. The inclusion of a PILON can protect the enforceability of other contractual terms (such as post-termination restrictive covenants) where employment is terminated with immediate effect. It will also mean that the practice some employers have adopted of structuring PILONs as damages payments in order for such payments to fall within the £30,000 exemption is no longer effective.
Less clear, however, and arguably introducing more complexity than it solves, is the government's proposal in relation to the treatment of other post-employment payments received by employees who do not work their full notice period. Under the draft legislation, all post-employment payments which would have been treated as general earnings if the employee had worked their notice period will be subject to income tax and NICs as earnings. The net is currently cast very wide, extending to "expected bonus income" which "includes commission, incentive and anything similar" and the draft legislation contains anti-avoidance measures designed to catch arrangements which seek to take post-employment payments out of the scope of earnings.
- Exemptions and reliefs. The government had been considering abolishing some of the exemptions and reliefs that apply to termination payments in addition to the £30,000 threshold. Reflecting the views of those who responded to last year's consultation, however, it has now confirmed that only the Foreign Service Relief (available, in certain cases, where an employee has worked outside the UK) will be abolished. In addition, the exemption from tax for payments made because of injury to the employee will be amended, to clarify that it does not apply to injury to feelings (a point that has come up in recent tax tribunal cases).
The current consultation is running until 5 October 2016, following which a second draft of the legislation will be prepared for publication with the draft Finance Bill 2017. We hope clarificatory changes will be made to the current drafting, especially in relation to post-employment payments.
As noted above the proposals will not come into force until April 2018, so employers have some time to review their existing contractual arrangements. Employers should consider whether they want to include PILON clauses in their employment contracts if they do not already do so, particularly if there are other contractual terms which they wish to enforce post-termination. Employers may also want to consider reviewing their standard form settlement agreements if there are provisions which do not sit comfortably with the above proposals.
Given the timing of these new measures, we may also see an acceleration of terminations in the immediate run up to April 2018, so employers can escape the new employers NICs charge on termination payments above £30,000.
We will be responding to the government to suggest clarification of the draft legislation, and would be pleased to include any comments our clients have. In the meantime if you have any questions relating to the consultation, please contact Barbara Allen or Purvis Ghani.