Employment Law Bulletin March 2018

Changes to the tax treatment of payments in lieu of notice on termination

The tax treatment of payments in lieu of notice (‘PILONs’) made to employees on the termination of their employment is changing.

The new rules will apply to all terminations made on or after 6 April 2018. At present, the tax treatment differs depending on whether a PILON is contractual or non-contractual. If PILONs are contractual they are subject to tax and National Insurance like ordinary salary. If they are non-contractual they are treated as compensation for loss of employment and paid free of income tax and national insurance up to the £30k limit.

From 6 April all PILONs will be taxable like ordinary salary, irrespective of whether they are contractual or non-contractual. Tax and national insurance contributions will be charged on the ‘Basic Pay’ the employee would have received if they had worked their notice. Basic Pay for this purpose is employment income, not including overtime, bonuses, commissions etc.

Clarification is also given in the new legislation as to whether compensation for injury to feelings should be taxable. There had previously been conflicting case law on this point. From 6 April only compensation for injury to feelings in respect of psychiatric injury or another recognised medical condition will be tax free.

The above change will result in more tax being payable on termination payments overall. In this light it is also worth noting that as part of the changes, the Treasury is being given the power to amend the £30k limit. We do not know if or when this power will be used by the Treasury but given the other provisions of the new legislation, it seems likely that the £30k tax free limit is only likely to be reduced over time.

Businesses should follow HMRC guidance which will assist with the calculations and provide more information on the trickier areas, such as how to deal with contributions to pension schemes on termination. Payroll teams should take tax advice on the relevant changes and ensure their payroll systems are updated before 6 April.