Termination Payments for Employees – Tax changes

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Benjamin Franklin wrote a letter in 1789 in which he stated famously, “In this world nothing can be said to be certain, except death and taxes”. Fast forward 229 years and actually taxation issues are far from certain in one distinct area of employment law, that surrounding termination payments, and in particular, those including notice pay.

From 6th April 2018 the position will be clearer for employers. This is helpful from a “certainty” perspective, but less helpful in relation to the ability to offer employees increased incentives to agree to leave their employment in exchange for a termination payment, with the use of a settlement agreement.

Employers regularly use termination payments in the course of negotiating a mutually agreed exit, often so that a formal but inevitable process can be avoided, and for the benefit of all concerned. In these scenarios, the employee concerned may be offered a payment on termination which is paid under a settlement agreement. The agreement essentially ensures that no legal action can be taken against the employer, and in consideration of this, the employee receives a sum of money, the termination payment. This amount generally includes entitlements such as notice pay, redundancy pay and ex gratia payments.

Termination payments up to the value of £30,000 can be paid tax free, anything over this amount attracts tax deductions. This has not changed. However, it has not been as straightforward as it may appear at first glance, and close examination of the employment contract in each case is necessary.

Currently, if an employee does not have a clause in their employment contract which allows for their notice payment to be paid “in lieu”, meaning that they do not have to work their notice but will be paid it in a lump sum, this amount could be added to the termination payment and paid tax free, as long as it is under the £30,000 threshold. If there is a “Payment in Lieu of Notice” (PILON) clause within the employment contract, notice always has to be treated separately and taxed in the usual way, anything else would attract unwelcome interest from the Inland Revenue and potentially viewed as tax avoidance.

The benefit for both employers and employees has been that as long as there is no PILON clause within the contract, and the termination payment was less than £30,000, the notice pay could be paid without deductions. It follows that this means the lump sum offer could be more attractive to both parties.

The Position from 6th April 2018

For termination payments due to be paid on or after 6th April 2018, any payment in lieu of notice will need to be taxed as earnings. The employer will need to calculate the extent of any unexpired notice the departing employee would have been entitled to and ensure that the payment for the equivalent period is subjected to tax and national insurance contributions. This applies whether or not there is a payment in lieu of notice clause (“PILON”) in the contract of employment.

This means that the need to closely inspect and interpret the employment contract has disappeared. This provides certainty, even when a situation may involve an employee who has been employed for so long that no-one has any track of their employment contract. However, it also means that the certainty takes away the ability to offer increased termination payments at no real cost to employers – and the benefit of the certainty lies with the Inland Revenue rather than the parties involved. Benjamin Franklin therefore appears to have been proved correct with this change.

About ArwenMakin_ESPLaw

Arwen Makin

After studying law at Cambridge University, I trained at leading national law firm Mills & Reeve, qualifying into their employment team in 2002. I have extensive employment law experience, gained through advising both employers and employees on a wide range of issues, across an array of sectors – including but not limited to finance, education, hospitality, transport and retail. This diverse experience means I am ideally placed to provide advice in relation to professional conduct and regulatory matters.

I am now a senior solicitor at ESP Law, part of ESP Group – a very different employment law firm and HR consultancy business, with our own in-house legal and HR experts. Taking pride in our reputation for delivering sensible, straight-talking and practical advice – at the same time as being approachable and supportive – I am passionate about the way ESP works with its customers. By building on trusted relationships and providing prompt support at the earliest stage of any issue, we help ensure that sound commercial decisions are taken.

The vision for our business was to deliver an exceptionally personal, yet cost-effective service that truly meets the evolving needs of modern and forward-thinking HR teams and their organisations. I’m lucky to be among a team of very talented employment lawyers who work hard day in, day out, to make this vision a reality.


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