Changes to tax treatment of termination payments Before 6 April 2018 The position on payments received on termination of employment was: Payments in Lieu of Notice (PILONs) • Any payment received in accordance with the employee's contract of employment was subject to income tax and class 1 NICs (with the corresponding deductions under PAYE) – this would include a PILON that is provided for under the contract of employment (either as automatic or discretionary). • Any non-contractual payments were only taxable (but without NICs) to the extent that they exceeded £30,000 (under the special rules that tax amounts arising in connection with termination of employment). Where the contract of employment was silent on PILONs, any PILON was treated as non-contractual unless there is very strong "custom and practice" making the payment effectively contractual. Salary sacrifice Employees could elect, if they so wished, to sacrifice all or part of their taxable payment into a nontaxable benefit – principally into a pension contribution (subject to the other conditions around salary sacrifice).
Foreign service exemption • Where the employee worked for part of the time outside the UK: o If more than 75% of the time was outside the UK, the non-contractual payments were not subject to UK tax o If less than 75% of the time was outside the UK , there was an apportionment of the amount subject to UK tax Changes from 6 April 2018: PILONs • After allowing for any statutory redundancy payment, to the extent that the employee's notice period is not worked:
o an amount corresponding to the employee's basic pay; o excluding bonuses, overtime, commission, etc; and o ignoring any salary sacrifice, is treated as being employment income subject to income tax and NICs. • The intention is to tax (and subject to class 1 NICs) as earnings the basic pay an employee would have earned had the employee worked his or her notice in full. Accordingly, the tax treatment no longer depends on whether there is a contractual PILON in the contract of employment. • Only non-contractual amounts in excess of the above are not subject to NICs and can benefit from the £30,000 exemption.
Salary sacrifice • Salary sacrifice can only be operated on amounts that don't fall within the PILON provision above. Foreign service exemption • The partial foreign service exemption (where the employee has worked outside the UK for less than 75% of the period of employment) is being withdrawn – except in relation to any amount treated as a PILON under the provisions noted above. However, new exemptions will apply for UK resident employees with foreign seafaring service.
Other changes • Payments for injury to feelings to fall outside the exemption for injury payments, except where the injury amounts to a psychiatric injury or other recognised medical condition. • HM Treasury permitted to vary the £30,000 threshold by regulations. Changes from 6 April 2019: • All termination payments above the £30,000 threshold to be subject to class 1A NICs (employer liability only). Payments in lieu of notice from April 2018 A relevant termination award is the amount paid to an employee on termination of employment less any amounts for a statutory redundancy payment and/or any approved contractual payments.
Employers must then treat the part of the relevant termination award which reflects basic pay for any part of a notice period that is not served as earnings and subject that part to tax and NICs (employer and employee). The provisions refer to this as "post-employment notice pay" (PENP). What must be taxed as earnings? The part of the relevant termination award that must be treated as earnings is: • The entire termination award if the PENP is equal to or more than the termination award. • The PENP, if it is less than the termination award but is not nil. If PENP is a negative amount, it is treated as nil.
How to calculate PENP The calculation differs depending on various factors. The basic formula for an employee: • who is paid monthly • whose contractual notice period is expressed in months; and • whose employment is terminated with immediate effect or whose unworked periods of notice is a whole number of months is: BP x D – T, where: BP:
Basic pay for the last pay period to end before the day notice is given (assuming notice is given). Basic pay must include the value of any salary sacrifice arrangements (eg. for pension, childcare vouchers etc). Basic pay does not include benefits in kind or amounts: • received for overtime, bonus, commission, gratuity or allowance. • received in connection with the termination of employment. • relating to company sick pay, restrictive covenants and certain amounts that relate to employee shareholders. • that relate to shares or share options
D:
The number of months in the post-employment notice period. (Broadly the unworked period of notice.) Note: D is calculated by reference to the notice that the employer must give (by contract or law). This may be different from the period of notice that the employee must give.
T
Amounts (other than holiday pay and termination bonuses) that are paid on termination but are taxable as earnings.
Example: Employee A is: • paid £3,000 monthly (basic pay); • has a 3 month notice period; and • works one month of the three month notice period. A's employer makes a termination award of £10,000. Applying the formula: PENP = BP (3,000) x D (2) – T (nil) = £6,000. As the PENP is less than the termination award, £6,000 is treated as earnings and the balance is taxable as under section 403 ITEPA 2003 (though this would in any event be less than the £30,000 limit and so no tax). BUT: if part of the termination award is a statutory redundancy payment, the termination award is reduced accordingly. For example, if £5,000 of the £10,000 termination award is a statutory redundancy payment, the relevant termination award will be £5,000. In Employee A's case, as the PENP (£6,000) is greater than the relevant termination award, only the termination award, £5,000, would be treated as earnings.
Please note that this note is provided for guidance only and specific legal advice should be sought for individual and particular situations. For further assistance, please contact:
Leigh Sayliss Partner, Head of Business and Property Taxes T: +44 (0)20 3755 5526 E: leigh.sayliss@howardkennedy.com
Lydia Christie Senior Associate, Employment T: +44 (0)20 3755 5402 E: lydia.christie@howardkennedy.com
Jane Amphlett Partner, Head of Employment T: +44 (0)20 3755 5360 E: jane.amphlett@howardkennedy.com