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New rules for termination payments made on, or after, 6 April 2018

News 29th March 2018

HMRC is changing the way that termination payments are taxed.

Previously (subject to some caveats) one would expect the first £30K to be tax-free, and pay-in-lieu-of-notice (“PILON”) payments to be subject to tax only where there is a contractual entitlement to them.

From 6 April 2018, some termination payments – or at least, some parts of termination payments – will be chargeable as income tax and subject to Class 1 NICs. In effect, the slice of the termination payment which correlates with PILON will be taxable, regardless of whether there is a contractual entitlement to provide PILON.

HMRC has stated that this change applies to payments, or benefits received, on or after 6 April 2018 where the employment also ended on or after 6 April 2018.

The key change requires employers to split the termination payment into two elements. The first element represents the basic pay which the employee would have received but for the termination, i.e. while working out their notice. This is called “post-employment notice pay” (“PENP”) and is calculated by applying a specific formula.

The relevant legislation is here, and the formula is at s 402D under “post-employment notice pay”.

That “slice” of pay is chargeable as income tax & subject to Class 1 NICs; the remainder of the termination payment is treated as before (i.e. no tax up to £30K, but taxable thereafter).

Statutory redundancy payments and “approved contractual payments” are specifically excluded from the PENP calculation – those payments are treated as “specific employment income” and are subject to the £30K exemption where appropriate.

HMRC’s Employer Bulletin for February 2018 is here and covers the issue of PENP.

The amending legislation (i.e. Finance (No 2) Act 2017, amending ITEPA 2003) says that the amendments have effect for the tax year 2018-19 and subsequent tax years: s 5(10) Finance (No 2) Act 2017.

The “relevant tax year” for the purposes of treating payments as employment income is the tax year in which the payment or other benefit is received (s 403(2) ITEPA 2003), and a cash benefit is treated as received (i) when it is paid or a payment is made on account of it, or (ii) when the recipient becomes entitled to require payment of or on account of it (s 403(3)(a) ITEPA 2003) (whichever is earlier). And since the entitlement to payment presumably arises on the date of termination, the change will only apply to payments received where the employment also ends on or after 6 April 2018 – i.e. in the tax year 2018-19 (as above).

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