Termination Payments: What is changing in April 2018?

From 6 April 2018 the way companies must handle termination payments is changing. As announced by the Chancellor of the Exchequer during his budget speech in March 2016, new rules are coming in to simplify the tax treatments of termination payments and to halt a system that supposedly “incentivise employers to manipulate the rules”. Here we look at exactly what is changing and how it will affect you.

Current Rules

Termination payments are extremely common in today’s society, often utilised by employers as leverage in settlement agreement negotiations.   Currently certain payments made to employees as part of a termination payment are tax free up to £30,000. This is well known by employers and the majority of employers adhere to the rules regarding the tax deduction. So, what is this so-called incentivisation to manipulate the rules that has been highlighted by the Government?

The answer relates to PILON (or Payment in Lieu of Notice for those unfamiliar with the terminology). This type of payment, usually found in employment contracts, enables the employer to pay an individual the sum owed for a notice period, without the requirement for the individual to work and be employed during that notice period.

Under the current rules, it quickly became apparent to employers making termination payments that, where an individual’s employment contract contained a PILON clause, any period of notice not worked should be subject to the usual PAYE deductions for tax and National Insurance as it would constitute earnings from employment. However, where an employee’s contract did not contain a PILON clause, dismissing the employee immediately could technically be a breach of contract and therefore any sums payable to the employee, up to the £30,000 limit, may be able to be paid free of any deductions. This is the “incentivisation to manipulate the rules” that the Government, and in particular HMRC, are concerned about and an area where they believe tighter regulation needed to be brought in.

New Rules

The new rules take effect from 6 April 2018. 

So what do the new rules entail?

  • First of all, the PILON loophole is closing. The government and HMRC intend on treating any payment in lieu of notice, equivalent to an employee’s unworked period of notice, as earnings. Whether the employee has a PILON clause in their contract or not is now irrelevant. Such earnings, calculated at basic pay, will now always be subject to PAYE deductions (so tax and NI). The Government has even come up with a catchy classification for such payments which will now be known as Post Employment Notice Pay or “PENP”.

  • Utilising the tax exemption rules for injury to feelings payments is also changing. From April 2018, such payments will need to satisfy the requirements of being in respect of a recognised medical condition in order to meet the exemption criteria.

  • Foreign service relief will be abolished for UK residents.

With just under a month until businesses are required to comply with the legislation, we are still awaiting guidance from HMRC as to the interpretation of many of the points in the new rules.

One thing we have been told is that the suggested change to tax regulations requiring employers National Insurance Contributions to be paid on all termination payments over £30,000 has now been delayed until April 2019. This at least, offers some clarity to employers.  Currently there is no requirement to pay NI on termination payments over £30,000.

What should you be doing now?

All HR and payroll teams should be made aware of the upcoming changes prior to the April 2018 deadline. This article by no means attempts to cover every change in the upcoming tax regulations.  All businesses are advised to take specific tax advice to ensure that they stay on the correct side of HMRC.

What does this mean for your business?

Businesses who pay tax free PILONS will feel an increase in costs with the additional PAYE requirements on the same from April 2018.

Employers should also look ahead to the changes in April 2019 and the introduction of payments of employer National Insurance Contributions on termination payments over and above £30,000. 

When making payments under settlement agreements, employers should ensure that relevant tax indemnities are included in the agreement. This will assist in recouping any unpaid tax, NICs, penalties and interest should the business feel the wrath of HMRC.

Recommended Reading

The Government have released a report into the new rules which can be found HERE


These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.