Employers need to be aware of how the tax treatment of payments in lieu of notice will change for dismissals taking place on or after 6 April this year.
Treatment of all PILONs as taxable and subject to National Insurance contributions
Most employers and employee advisers will be aware that currently an individual with no PILON clause in their contract can often benefit from receiving a payment equivalent to their PILON as damages for loss of notice and therefore free of deductions from tax and NI up to the first £30,000. The exemption has long been a target of HMRC and there are a number of caveats to the current rule which mean it is not always an attractive route.
From 6 April 2018 this aspect of termination packages will be simplified (although to the disadvantage of employers and employees) and all PILONs, whether contractually provided for or not, will be subject to deductions for tax and NI in the same way as other earnings.
Statutory and contractual redundancy pay will continue to benefit from the £30,000 exemption. Unfair dismissal compensation no longer falls automatically into the exempted category.
Post-employment notice pay is the subject of a complicated calculation (set out below), so employers should be careful not to assume that the notice pay due under the contract equates to the amount that should be subject to deductions for tax and NI.
Calculating post-employment pay
Post-employment notice pay is defined as:
- basic pay for the last pay period to end before the trigger date
- multiplied by the number of days in the post-employment notice period
- divided by the number of days in the last pay period
- less amounts (other than holiday pay and termination bonuses) that are paid on termination but are taxable as earnings (for example payments for restrictive covenants).
The pay period is the period in respect of which the employee receives their salary or wages, typically a month or a week.
The trigger date is the day notice is given or if notice is not given, the last day of employment.
The post-employment notice period begins at the end of the last day of employment and ends with the earliest lawful termination date (specific provision is made for fixed-term contracts with no contractual notice provision).
Basic pay is defined as employment income disregarding overtime, bonuses, commissions, gratuities, allowances, termination awards, benefits in kind and amounts treated as earnings (such as share-based earnings). However, basic pay includes amount that would have been received were it not for a salary sacrifice arrangement having been in place.
What this means for employers
For dismissals contemplated from 6 April onwards employers will need to be careful not to make promises regarding treating payments in lieu of notice tax efficiently as this will no longer possible. Other aspects of any proposed deal may need to be sweetened, such as increasing the compensation sum payable under the agreement.
If you want to discuss any aspect of negotiating a settlement further please contact Phillip using the details below.