On 6 April 2019 the law relating to the taxation of termination payments will change. From that date, you’ll have to pay employers’ NI on any part of the payment that exceeds £30,000. What does this mean in practical terms?
Up until 5 April 2018 the tax rules stated that where an employer had a right or a discretion under the employment contract to make a payment in lieu of notice (PILON) on the termination of employment, the payment would be classed as normal earnings and subject to income tax and Class 1 NI in the usual way. These are payable by the employee but deducted by the employer.
£30,000 exemption removed
Where there was no PILON clause, or a discretion was not exercised, a termination payment was classed as damages, i.e. compensation, for the employer’s breach of contract. In this situation, the first £30,000 of the termination payment could be paid free of income tax and NI due to a statutory exemption. On 6 April 2018 the distinction was removed and all termination payments are subject to income tax and NI, no matter what the employment contract says.
The statutory formula
To work out the amount payable, you must calculate exactly how much of the PILON is post-employment notice pay (PENP). PENP is essentially the basic pay that an employee would have received for any unworked period of notice, minus any contractual PILON they are entitled to receive. Unfortunately, there’s a complicated statutory formula which must be used to calculate the actual PENP figure. You should calculate PENP for all employees whose employment is terminated, including those whose contracts contain an express PILON clause.
A nil PENP
Whilst you must make this calculation in every circumstance, the PENP will always be “nil” where an employee works out their full contractual notice period, i.e. they don’t leave, or are asked to leave, part-way through that notice period.
Tip. Where you need to calculate a PENP using the statutory formula, follow the guidance set out in HMRC’s manual (see The next step ).
More new rules
On 6 April 2019 there will be a further change to the taxation of termination payments (this change was originally due to take effect in 2018 but was delayed). From that date, you’ll also be required to pay employers’ NI on any part of a termination payment that exceeds £30,000. This exemption doesn’t relate to employees’ NI, so you’ll need to amend your payroll procedures accordingly.
Tip. The practical effect of this change is that a termination payment could cost you more overall because you’ll have to pay an additional 13.8% on the balance over £30,000. If you have any costly termination payments on the horizon, you can avoid this additional cost by concluding matters fully before 6 April 2019. Employment must also terminate before this date.