Date of publication: November 2018
There is a generous tax exemption available which allows up to £30,000 to be paid to an employee tax free as part of a severance payment on termination of their employment. However, new legislation has changed the tax treatment of payments in lieu of notice (PILON) which now makes PILONs fully taxable and subject to both employee and employer National Insurance Contributions (NICs) regardless of whether there is a PILON clause in the contract of employment.
Therefore, there is no longer a major tax advantage in not including a PILON clause in an employment contract.
The new rules essentially split termination payments into two parts:
If the PENP is equal or greater than the entire termination award, then the £30,000 exemption does not apply, and the entire amount is fully taxable.
If the PENP is less than the entire termination award, only the post-employment notice pay is treated as taxable earnings and will still benefit from the first £30,000 being exempt from income tax. The remainder will be taxed as employment income.redundancy.
The calculation of PENP differs depending on a number of 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:
Note that 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.
This is a complex and grey area and there are detailed requirements. It should also be remembered that in addition to the tax considerations outlined above there are legal requirements connected with termination of employment. An employer should therefore ensure they take advice on both the tax and the employment law aspects of this complex issue.
Disclaimer: This note does not contain a full statement of the law and it does not constitute legal advice. Please contact us if you have any questions about the information set out above.
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