06 Apr 2018

Taxing times - All change for payments in lieu of notice

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New tax rules apply to payments in lieu of notice paid in respect of employment terminations on or after 6 April 2018.

All payments in lieu of notice (including payments for part of the notice period) will be subject to income tax and NI contributions regardless of whether the contract of employment contains a payment in lieu of notice clause.

This does not apply to payments in lieu of notice for those employees whose employment was terminated prior to 6 April 2018 but who are paid after this date.

Out with the old

Previously, a payment in lieu of notice was only subject to income tax and NI deductions where it was contractual or the employer had a custom and practice of paying notice in this way. Any payment in lieu of notice which fell outside of such arrangements could be paid tax free up to £30,000 and free of NI contributions giving employees more money in their pocket.

In with the new

From today, where notice is paid in lieu, the concept of post-employment notice pay (PENP) will apply. The PENP represents the amount of basic pay the employee would have received had they been given full notice rather than being paid in lieu.

PENP will be calculated by applying a formula: the employee's basic pay multiplied by the number of days'/months' notice they should have received, divided by the length of the employee's ordinary pay period. Subtract from this any termination payment which has already been paid subject to deductions and it is the product of this calculation, the PENP, which will be subject to income tax and NI. The remainder is taxed as a termination payment.

The calculation should be applied even where a payment in lieu of notice has already been determined to ensure the correct deductions are being made under the new rules.

Subject to further guidance from HMRC, the new rules apply as follows:

  • For the purpose of the PENP calculation:
    • overtime, commission, bonuses and benefits in kind are not included in basic pay;
    • basic pay must include any amount which is sacrificed via a salary sacrifice; and
    • statutory, and potentially contractual, redundancy payments are carved out.
  • There may be scope for tax saving by making termination payments directly into a pension scheme.

Key practical point

The tax benefit which arose from excluding a payment in lieu of notice clause in a contract of employment has gone. Payment in lieu of notice clauses should now be commonplace in all contracts of employment.

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Kate Brearley

Kate Brearley
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Natalie Edwards

Natalie Edwards
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