There is now only a month to go until major changes to the tax calculations for termination payments come into effect from April 2018 which will specifically hit high earners and affect the value of tax due.
The new rules, which were originally part of the 2016 Budget but then shelved, now form part the Finance (No. 2) Act 2017.
The measure clarifies the scope of the exemption for termination payments through a number of changes. All payments in lieu of notice (PILONs) will now be both taxable and subject to Class 1 NICs.
The legislation requires the employer to identify the amount of basic pay that the employee would have received if they had worked their notice period, even if the employee leaves the employment part way through their notice period. The amount will then be treated as earnings and will not be subject to the £30,000 income tax exemption.
HMRC says this measure is intended to bring fairness and clarity to the taxation of termination payments by making it clear that all PILONs, rather than just contractual PILONs, are taxable earnings. All employees will pay tax and Class 1 NICs on the amount of basic pay that they would have received if they had worked their notice in full, even if they are not paid a contractual PILON.
This means the tax and NICs consequences are the same for everyone and it is no longer dependent on how the employment contract is drafted or whether payments are structured in some other form, such as damages.
The existing £30,000 income tax exemption will be retained and employees will continue to benefit from an unlimited employee NICs exemption for payments associated with the termination of employment. This will ensure that those who lose their job will be supported through the tax system.
The legislation splits an employee’s termination payment into two types of payment: payments that can still benefit from the £30,000 threshold and those that cannot. The legislation works by first identifying any payments that should be treated as earnings and any remainder is then subject to the £30,000 exemption.
The measure also makes changes to certain exemptions in the termination payments legislation. It removes foreign service relief, with an exemption for seafarers, and clarifies that the exemption for injury does not apply in cases of injured feelings.
Additional changes will then come in to play from 6 April 2019 which will affect the value of NICs due. They make an employer liable to pay NICs on any part of a termination payment they make to their employees that exceeds the £30,000 threshold. Previously, any amount in excess of the £30,000 has only been subject to tax so this will be a real cost to employers.
In its policy paper published in autumn 2017, HMRC said it is anticipated that this will be collected in real-time, as part of the employer’s standard weekly or monthly payroll returns and remittances.
Initially, this change was also due to be effective from April 2018, however a delay from the Government in agreeing the changes to Class 2 NICs has also impacted the NIC timings for termination payments.
According to the impact note, HMRC expects the changes to provide over £400m of additional tax annually from 2018/19, rising to £485m by 2020/21.
If you require any support or advice in structuring efficient termination packages please contact Charlotte Stewart (firstname.lastname@example.org) or your usual AAB contact.