The landscape of employment taxes is slowly starting to shift, with changes to salary sacrifice arrangements and calculation of company car and accommodation benefits where an employee reimburses the employer. The latest shift to take place in relation to the taxation of termination payment started to come into being on 6 April 2018 with more changes arriving a year later on 6 April 2019.
The old rules
Historically, where an employee didn’t work their contractual notice period they received a “Payment in Lieu of Notice” or PILON as they became known. Over time, a whole series of case law developed around whether this should be taxable or not.
The question that arose was “Is the PILON a contractual right or not”? If so, then it would be subject to tax and national insurance under the normal earnings legislation.
However, if it wasn’t a contractual right then it could be classed as damages instead. This would mean the amount falling within the £30,000 exemption would be received free from tax and national insurance.
In turn, this led to a lot of creative planning with employee contracts in order to demonstrate that the PILON wasn’t a contractual entitlement.
In addition, there was also a national insurance anomaly in that although termination payments over £30,000 were subject to income tax, the same didn’t apply to national insurance. Hence any termination payments received in excess of £30,000 were not subject to national insurance.
6 April 2018 Changes
The rules for taxing PILONs where they are a contractual element of an employee’s contract remain in place, and are so are subject to tax and national insurance under the general earnings legislation.
However, where the PILON isn’t contractual, and would previously have been covered by the £30,000 termination payment exemption it is now added to any other termination payments received so giving a global termination payment figure.
Taking this figure it is now split into two parts:
- “post-employment notice pay” or PENP, calculated by a statutory formula (see below)
- balance to be set against existing £30,000 termination exemption
- £2,500 salary per week
- Statutory notice period – 6 weeks
- Contractual notice period – 2 weeks
- Contractual PILON of £5,000
- Termination 18 July 2018
- Termination payment received £85,000 made up as follows:
- £25,000 Statutory Redundancy Pay
- £5,000 contractual PILON
- £55,000 termination payment
Step 1 – Calculate the PENP using the formula:
((BP X D)/P)-T
BP – employee’s basic pay from last pay period
D – no of calendar days in post employment notice period
P – number of calendar days in last pay period
T – any amounts taxed elsewhere
BP – £2,500
D – entitled to 6 weeks (42 days), but not given any
P – weekly paid so 7 days
T – £5,000 PILON
PNEP: ((£2,500 x 42)/7)-5,000 = £10,000
Step 2 – Establish balance of termination payment available to set against £30,000 termination payment exemption:
£55,000 – £10,000 = £45,000
Summary of Tax Treatment
|Item||£||Tax and National Insurance Treatment|
|Contractual PILON||£5,000||Tax and National Insurance|
|PENP element of termination payment||£10,000||Tax and National Insurance|
|Balance of termination payment|
(£55,000 – £10,000)
|£30,000 termination payment exemption||(£30,000)|
|Balance||£40,000||Tax and currently no national insurance but see below for post 6 April 2019 changes|
6 April 2019
The anomaly of no national insurance being due on the termination payment exceeding £30,000 is being dealt with through a separate piece of legislation, and hence only takes force with effect from 6 April 2019.
From 6 April 2019, the national insurance on termination payments will be as follows:
- No employee’s national insurance on the whole termination amount
- Class 1A employer’s national insurance on termination payments exceeding £30,000
Care and consideration should be given when looking to structure an employee’s termination package in order to be able to maximise the exemptions that are still available. If you’re in the position where you are considering this, then it is recommended that professional advice be sought to avoid any nasty tax surprises.
I trust the above has given some helpful pointers, if there are any employment taxes areas you would specifically like covered then please let me know – my contact details are below, or you can visit https://www.cottonsaccountants.co.uk/
All the best,