Ending an Employee Relationship
Undoubtedly employers dread the thought of ending an employee relationship but it is a common misconception that the first £30,000 of any termination package is payable tax-free.
Most recently, the Government saw this as a potential area of abuse and, following a consultation, legislated new rules which apply to termination payments made from 6 April 2018.
Under the old rules, a contractual Payment in Lieu of Notice (PILON) would be subject to income tax and primary Class 1 NIC for the employee, as well as secondary Class 1 NIC for the employer. However, non-contractual PILONs would benefit from the £30,000 exemption which would reduce the tax for the employee and eliminate the NIC charge for both the employer and the employee.
From 6 April 2018, all PILONs are both taxable and subject to Class 1 NICs. The employer is required to identify the amount of basic pay that the employee would have received if they had worked their notice period, even if they leave part way through the notice period. This will include all holiday pay entitlement, bonuses or benefits in kind provided for the same period. The result will be treated as earnings subject to tax and Class 1 NICs, with no entitlement to the £30,000 exemption.
All non-contractual termination payments or redundancy payments will continue to be regarded as termination payments which can benefit from the £30,000 exemption. Any excess is taxed at the employee’s marginal rate. However, whilst such excess payments are currently NIC free for both the employer and the employee, the employer will have to pay Class 1A NIC (13.8%) on the excess from April 2019.
The final change relates to Foreign Service Relief (FSR), which applies when an employee who has worked abroad for some, or all, of their contract receives a non-contractual termination payment. Depending on the amount of time spent overseas, this can either partially or fully exempt the termination payment. From April 2018 FSR will only apply where the employee is not resident in the UK during the tax year when the termination payment is received.
FSR will still be available if the employee is employed as a seafarer or is receiving a payment following a change to their employment duties or earnings, rather than on the termination of their employment.
The tax treatment of termination payments can be complex and the new calculation will need to be considered in detail when considering how much of a payment should be subject to income tax and NIC. However, the new legislation does mean that the tax treatment is no longer dependant on how the employment contract is drafted or how the payment is structured.
Whilst we hope that you do not have to make such a payment, if you are uncertain as to whether a termination payment will be taxable, please do get in touch.