Taxation of termination payments from 6 April 2018
With effect from 6 April 2018, the way in which termination payments are taxed is changing.
In summary, the key changes are:
- All payments in lieu of notice (“PILONs”) will be subject to tax and class 1 National Insurance Contributions (“NICs”)..
- Payments for injury to feelings will fall outside the exemption from tax for injury payments, except where the injury amounts to a psychiatric injury or other recognised medical condition.
The changes take effect from 6 April 2018. The changes affecting PILONs apply to payments or benefits received on or after 6 April 2018 where the employment also ends on or after 6 April 2018.
The changes to PILONs mean that all employers will be required to tax the basic pay an employee would have earned had they worked out all of the notice period that the employer is required to give. The amount that is subject to tax represents “post-employment notice pay” (“PENP”). PENP is calculated by applying one of two formulae set out in amendments to the Income Tax (Earnings and Pensions) Act 2003. Whilst the formulae are complex, generally speaking, if there is any remaining balance of a termination award once PENP is deducted, it can be paid tax and NIC free up to £30,000.
The tax-free status of statutory redundancy payments is not affected by these changes.
Employers will be required to apply one of the two PENP formulae to the total amount of relevant termination payments. They should operate PAYE to deduct income tax and NICs from the amount of PENP from 6 April 2018.
We understand that detailed guidance on this area will be published in HMRC’s Employment Income Manual shortly. In the meantime, employers are advised to seek expert legal or tax advice should they have any questions when it comes to calculating PENP.Back to Our Thinking →