Is the £30,000 Tax Free Limit Still Available for Employee Termination Payments?

Wednesday 7th February 2018

This has been an FAQ for us ever since it was mentioned as being set to change in the 2016 budget statement. The answer is: for the payment in lieu element, not for much longer!

Indeed, the time is now upon us and employers who are planning to make termination payments to leavers on or after 6 April 2018 need to be aware of these changes.

The main and significant change is that all payments in lieu of notice (“PILONs”) will now be taxable and subject to both employer and employee National Insurance Contributions. A PILON equates to the value of a notice period which is not worked.

Currently, the taxable status of a PILON is dependent on whether there is a contractual provision in the employment contract relating to the right of the employer to make a PILON. We have been able to say up to now that where there is no contractual PILON clause in the contract then the first £30,000 of the PILON could be paid tax free – the explanation for this is that where the payment strictly flows from the termination it attracts the exemption whereas where it flows from the employment contract it must strictly be treated as remuneration and taxed accordingly. Under the new rules, there is no change to the treatment of contractual PILON payments which remain taxable as they always have been.

A downside to this change is that termination payments will look less beneficial to employees and packages may have to increase to overcome the effect of the tax charge. Additionally, employers may want to revisit their decisions not to include PILON clauses in contracts: some employers have historically chosen not to do so because of the tax. We have generally advised against such an approach because, by having a PILON clause, you can maintain the enforceability of your post-termination restrictive covenants.

The new rules require employers to work out specifically how much of the termination payment is deemed to be subject to tax and NICs taking into account basic pay, plus the value of any salary sacrifice arrangements. This is known as “post-employment notice pay” or PENP. Anything over and above that sum (which is not otherwise chargeable to tax) will be subject to the £30,000 tax free exemption. This does represent a slight change because many contracts refer only to basic pay but the new rules require the value of any salary sacrifice to be added on which, of course, may result in an additional tax and NIC liability.