Taxation to termination payments changing

Changes to the treatment of termination payments made to departing employees have been in effect from this April, with another change delayed until April next year, and not getting things right when an employee leaves can leave employers with a nasty and unexpected tax bill.

“This is a complex area of the legislation, and one which people frequently get wrong”, said Tax Manager, Andrew Cowe.  “There seems to be a common misconception that, when an employee departs, anything they are paid up to £30,000 is tax free.  Whilst that can be the case, it is far from automatic, and both the new and upcoming changes mean there is a new rule book to get used to.”

“You have to draw distinctions between payments which are actually earnings, statutory redundancy payments, and genuine compensation for the individual’s ‘loss of office’.  Only the latter two can be tax free, and that has always been the case.  Of course, this leads to a temptation to describe payments as anything other than earnings, but that is now more difficult.  Armed with a ‘beefed up’ rulebook, HMRC will be looking at this more closely”.

“The major change surrounds payments in lieu of notice (PILONs).  Previously, providing there was no provision for a PILON in an employee’s contract, employers were often able to pay the employee’s notice period tax free up to the £30,000 limit, and free of National Insurance (NIC) regardless of the amount.  However even where there was no clause, if the employer had a practice of making such payments, HMRC would often dispute the ‘tax free’ status of the payment”.

“The new rules take this a step further by stating that employers will always have to deduct tax and NIC from the equivalent of what would have been paid if the employee had worked the notice period”.

“The next rule change, thankfully now delayed a year, will charge employer’s NIC where there is a genuine redundancy payment, but in excess of the £30,000 limit. Currently such a payment would attract tax, but no NIC.  NIC will be applied for all such payments from 6 April next”.

“HMRC are stating that the new rules will make things simpler. But while that does appear to be true, it is surely no coincidence that this will also raise more tax than the old system!  As always, we recommend taking detailed advice on the individual situation before making any payments of this nature”.

Andrew Cowe, Tax Manager, Brearley & Co