Taxation on Termination – The Price of Simplicity

Morrish SolicitorsEmployment, Site NewsLeave a Comment

HMRC has published a piece of draft legislation which attempts to simplify the current regulations surrounding taxation of termination payments. The legislation is due to come into force in April 2018 and is currently open to consultation until the 5th of October 2016.

It has been suggested that the overall complexity of the current tax rules in terms of termination payments make the system overly open to manipulation, therefore, a number of simplifications have been suggested.

Firstly, I will address changes to PILONS. PILONs or payments in lieu of notice currently take two main forms, contractual and non-contractual. Although almost identical in nature the fact that one is contractual and one isn’t makes all the difference for tax purposes. Currently if you are contractually entitled to a PILON it will be subject to tax, however, non-contractual PILONs will not. This seems like an arbitrary difference.

There are two ways to potentially fix this situation but only one obvious one for HMRC. So, it will not come as a surprise that they have proposed to make all PILONs taxable regardless of contractual status. The distinction between the two forms will stay for clarity’s sake but in terms of tax they will be treated equally.

How this change will affect the use of PILONs is yet to be seen, however, now that the loophole has been plugged it certainly makes non-contractual PILONs less attractive from an employee’s perspective. Overall it seems that the simplification of PILONs has come at the expense of the employee, just how much expense is yet to be determined and could potentially lead to employers being asked to increase PILONs to account for the extra tax.

Secondly and probably most importantly is the confirmation that the £30,000 tax free allowance on termination payments will remain intact. This has been debated on numerous occasions and it comes as a welcome surprise that it has emerged relatively unscathed.

However, a key change that has been proposed is the introduction of employer national insurance contributions on payments over £30,000. This change will mean that on any termination payment over £30,000 employers will be liable to pay national insurance contributions. This may seem irrelevant to employees at first glance but the implications could be quite serious.

Two things seem fairly certain with this change:

  1. Firstly, Employers will be less likely to want to venture over the £30,000 tax fee allowance in terms of payment;
  1. Secondly, if they do venture over the tax free allowance the tax is likely to impact the amount of settlement, meaning the employee may have to foot the NIC bill instead of the employer.

Given that the highest rate of employer’s NIC in 2016-2017 is 13.8% that could constitute a large deduction from any employee’s likely settlement. Overall I think it’s fair to say that if this new procedure is introduced it will see employees disadvantaged in many cases.

Finally, the last major change is the confirmation of taxation on injury to feelings awards. Currently there is conflicting case law surrounding this subject which HMRC have attempted to clarify by putting a blanket tax on all injury to feelings awards. Again this is not ideal for employees, particularly since injury to feelings awards often seek to compensate for some particularly horrendous treatment by employers. With current income tax rates ranging from 0 – 45% this could significantly reduce the settlement amount that the employee actually receives.

Clearly there is a price to pay for simplicity and as the draft legislation stands it will likely be employees paying the lions share, however, it is worth reiterating that this is merely the draft legislation and much could change before the implementation date in 2018.

Link to the draft legislation.

James Battle – Legal Assistant

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