Major reforms to the tax treatment of termination payments have important implications for employers. Eleanor Longworth discusses the main issues.
Employers proposing to make termination payments should be aware of significant changes that take effect on 8 April.
The reforms mean the monetary value of all notice periods that are not worked will be taxable and subject to both employer and employee National Insurance Contributions (NICs). This is irrespective of whether or not there is a contractual payment in lieu of notice (PILON) clause.
Under the present rules, the value of a notice period can usually be paid tax and NIC-free if the contract of employment does not contain a PILON clause.
The reforms remove the tax advantages of not having a PILON clause. The upshot of the changes is that employers may have to change their approach to termination payments and in some cases, may have to consider offering enhanced termination packages to make them more attractive to employees.
Why the new legislation is being introduced
The changes are being implemented by the government to ‘clarify and tighten’ the tax treatment of termination payments and it is crucial that the termination payment is taxed and subjected to NICs correctly. This is because HMRC can recover unpaid tax and NICs, penalties and interest from the employer. It’s also important for employees because this burden is often passed to the employee via the settlement agreement.
What impact will the new rules have?
Effectively, if the notice is not worked, an amount equivalent to the employee’s basic pay must be subject to tax by the employer.
In practice, the proportion of the severance package allocated to notice is immaterial. The new system means employers must perform a prescribed calculation to work out how much of the termination payment will be subject to tax and NICs as ‘post-employment notice pay’ (PENP).
Apart from making non-contractual PILONs taxable, many calculations will be fairly uncomplicated, especially if a notice period is a round number of months.
The situation is less straightforward where an employee’s notice period is set out in weeks, which can skew the calculation. The situation will also be complicated where salary sacrifice is concerned because the new legislation means the value of salary sacrifice must be included in the calculation.
What employers need to do next
It is extremely important that employers are aware of these changes and that their new settlement agreements are drafted accordingly. Employers should also be aware that many template agreements held internally may now be out of date.
Employers are advised to take specialist professional advice to ensure their settlement agreements are correctly drafted to minimise the risk to the employer and employee.
For further advice on the new rules for termination payments, call Eleanor Longworth on 0161 761 8082, or email her at eleanor.longworth@whnsolicitors.co.uk
