Taxation of settlement payments

Tuesday 23 August 2016

There are a number of dates you might want to save for April 2018: the Commonwealth Games in Australia, the Rugby World Cup Sevens in San Francisco or the Grand National at Aintree. What you perhaps didn’t know is that in April 2018, draft legislation concerning changes to the taxation of termination payments is intended to come into force.

Though certainly not as exciting as a day at the Races, there are 3 key changes being made to the taxation of termination payments of which you should be aware.

The main changes will:

• make all payments in lieu of notice (PILONs) taxable, even if they are non-contractual;
• require payment of employer National Insurance contributions (NICs) on sums over £30,000 (NICs are not currently payable); and
• ensure payments for injury to feelings are subject to tax (there is currently a conflict of jurisdiction on this matter).

Why are changes being made?

The Government claims it has several objectives for the tax and NICs rules which can be achieved by making these legislative changes. These objectives are to:

• continue to support individuals when they lose their job;
• clarify the scope of the exemption for termination payments;
• align the rules for income tax and employer NICs so that employer NICs will be payable on payments above £30,000 (currently subject to income tax only);
• remove foreign service relief; and
• clarify that the exemption for injury does not apply in cases of injured feelings.

The Government believes that by making these changes the £30,000 income tax exemption can be retained and employees will continue to benefit from an unlimited employee NICs exemption – thereby continuing the support given to those who lose their jobs. The Government’s declared aim is to remove the uncertainty around different payment types, and so ensure that the £30,000 exemption can only be used for payments that are genuinely the result of an individual losing his or her job.

What are the likely consequences of these changes?

• Employees are likely to demand larger termination packages to compensate for the extra tax payable. As the typical employee who will be affected by this change will be a higher rate tax payer, this points to a £12,000 hike in such an employee’s expectations;
• Employers may attempt to attach a redundancy label to a dismissal when, in fact, dismissal is occurring for a different reason. This could lead to an increase in the number of Employment Tribunal claims;
• More claims may progress to an Employment Tribunal hearing where an employee can potentially recoup the lost tax-related advantage by receiving a non-taxable Tribunal award. This would in turn limit the prospect of achieving an agreed settlement, thereby costing businesses more time and money.

The precise wording of the draft legislation is open for consultation until 5 October 2016.