The current position
At present, when an organisation exits an employee certain payments (Termination Payments) fall into two categories, taxable and non-taxable.
One of the most common Termination Payments is a payment in lieu of notice (PILON), i.e. a payment equivalent to the balance of the employee’s notice period without them having to work it.
The tax position on PILON essentially boils down to whether there is an express PILON clause in the contract of employment:
- If there is, the PILON will needs to be taxed at the appropriate rate
- If there is no PILON clause and provided the organisation does not routinely make PILON payments when it exits staff, the PILON can be paid tax free. The reason being that it can be paid as compensation for the employer’s breach of notice provision i.e.: paying notice when the employee had a contractual right to work the notice.
The current threshold is £30,000. Anything over this sum should be taxed at the individual’s normal tax rate.
HMRC have been carefully scrutinizing tax free PILON payments.
The Government’s proposed changes
Through the Finance Bill, the government is currently looking to ‘clarifying and tighten’ the treatment of Termination Payments.
Firstly, they are proposing that NICs will now be charged on Termination Payments over the £30,000 threshold where Income Tax is payable.
Secondly and for the purpose of this article, the government want to treat all PILONs as earnings and therefore subject to tax and NIC deductions.
They have introduced a ‘post-employment notice pay’ (PENP) calculation that, broadly speaking, calculates the salary that the employee would have received, had they worked the balance of their notice period.
The PENP is a somewhat confusing calculation and will require more information than is currently required to calculate the employee’s notice period and, in the authors view, is a rather long winded approach to what could have been very simple! Regardless, we have provided a brief example below.
The Company exits an employee. It decides to pay the employee £10,000 as a Termination Payment.
The employee is paid £2,000 a month with a notice period of 60 days. There were 30 days in the last pay period.
£2,000 x 60 / 30 = £4,000.
£4,000 becomes the PENP and would be subject to tax and NIC.
The balance of £6,000 would then need to be broken down to determine whether the reminder:
- Is subject to the £30,000 threshold above
- Will be automatically taxed and have NIC deductions accordingly.
Did I say confusing? I meant ridiculously and unnecessarily complicated!
What is the motivation for this change? It is anticipated that by 2020 to 2021 the Exchequer will receive an additional £485 million in revenue, following this change.
When will these changes occur?
The above changes come into force on the 6 April 2018
What this means for your organisation
Whilst the government rakes in the additional revenue, it will be the organisations and individuals who feel the pinch. We consider the above will severely impact on termination negotiations and see an increase to costs for organisations to offer the same kind of exit packages that can currently be made.
We are also unconvinced that the above calculation brings any sort of clarity to the method of considering whether PILON should be taxed and instead will mean that no two calculations will be the same, meaning more work for employers.
To try and help you, we have set out some points for consideration below:
- Review your contacts with the view to revising them to include PILON provisions and how they will be calculated
- Consider whether you wish to exit any individuals prior to April 2018 to allow you to take advantage of the greater incentive that you could offer.
For more information on income tax and national insurance visit the GOV.UK website