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Termination payments and tax - update on PILONs
- AuthorKathryn Bolton
From 6th April 2018, the rules on taxation of termination payments are changing. In particular, the £30,000 exemption for certain termination payments will no longer apply to payments in lieu of notice (PILONs).
Historically, PILONs have been an especially complex area and, as a result, the tax treatment of PILONs will fundamentally change.
PILONs can cover various scenarios, for example:
• An employer gives proper notice of termination to the employee in accordance with the contract, tells the employee that they need not work until the termination date and gives the employee the wages attributable to the notice period in a lump sum;
• The contract of employment provides expressly that the employment may be terminated either by notice or, on payment of a sum in lieu of notice;
• The employer and the employee agree that the employment is to terminate immediately on payment of a sum in lieu of notice;
• Without the agreement of the employee, the employer summarily dismisses the employee and tenders payment in lieu of proper notice.
Before 6th April 2018, any PILON made under a term of the employment contract (implied or express) is taxable and does not qualify for the £30,000 tax exemption or exclusion from NIC-able earnings. However, PILONs not made pursuant to an (implied or express) contractual PILON clause can, prior to 6th April 2018, generally qualify for such exemptions.
However under the new regime, i.e. from 6th April 2018, there will generally be no difference in the tax treatment between contractual PILONs and non-contractual PILONs. PILONs which are not paid pursuant to contractual PILON clauses will be treated as earnings (and therefore fully taxable and subject to employer's Class 1 NICs).
HMRC has informally indicated it considers the new regime to apply only where the termination of employment itself occurs on or after 6th April 2018. As a result, any terminations which take place on or before 5th April 2018 will, according to HMRC, be taxed under the old regime, regardless of when the termination payments are made (ie even if they are made on or after 6th April 2018). It is anticipated that HMRC will include guidance on this point in an update to the Employment Income Manual prior to 6th April 2018.
Some employers presently choose to include a PILON clause in their contracts of employment to benefit from the tax advantage, even though this could prevent them relying on restrictive cove-nants if they want to terminate summarily and pay in lieu of notice. The justification for this will fall away from April. Employers should consider including a PILON clause in their contracts as standard from now on which may avoid having to carry out the more complicated new statutory calculation, assuming the PILON figure is greater than the amount deemed to be basic pay for notice unworked.
Employers need to bear in mind that only 'basic pay' for the unworked notice period is taken into account where there is no provision in the employment contract for payment of a PILON. Basic pay excludes, for example, overtime, commission or bonuses but it can't be assumed that all such additional payments will not be treated as taxable earnings. The uncertainty surrounding such payments looks set to remain despite the new legislation.
Basic pay does include salary that would have been received had it not been sacrificed for a benefit in kind, so employers must take care not to overlook this figure.
Where a fixed term contract (containing provisions for early termination), is terminated, the payment of salary for the remainder of the fixed term will no longer be treated as compensation subject to the £30,000 tax exemption. The basic pay due between the early termination date and expiry of the fixed term will be fully taxable as earnings and subject to National Insurance.
There are new anti-avoidance provisions to prevent parties manipulating pay to produce a lower amount for tax reasons.
If you require any support or guidance in the area please contact Kathryn Bolton or a member of the Employment team by calling 01522 512123.