New rules for the tax treatment of termination payments of PILON.
New rules for the tax treatment of termination payments of payments in lieu of notice (PILON) are being introduced from 6 April 2018.
General tax law for termination payments
In general, payments made to a director or employee by way of reward for services, past, present or future, is within the general earnings rules. In the case of Mairs v Haughey HL 1993, 66 TC 273 it was held that a non-statutory redundancy payment would not be within the general earnings charge, being compensation for the employee’s not being able to receive emoluments from the employment rather than emoluments from the employment itself.
HMRC Statement of Practice SP 1/94 provides further details on this matter:
Treatment before 6 April 2018
These ‘termination payment rules’ apply to payments and other benefits which are received directly or indirectly in consideration or in consequence of, or otherwise in connection with:
- the termination of a person’s employment
- a change in the duties of a person’s employment
- a change in the earnings from a person’s employment.
The payment or benefit may be received by the person, or the person’s spouse, civil partner, blood relative, dependant or personal representative, or provided on the employee’s behalf or to his order. A payment taxable under any other tax legislation is not within these provisions.
Termination payments which come within section 403 ITEPA 2003 are tax free up to £30,000 with the excess being subject to tax at the taxpayers’ marginal rate.
Amendments from 2018/19 onwards
Whether or not the employee is entitled to a contractual payment in lieu of notice, 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.
The new legislation in sections 402A to 402E ITEPA 2003 applies to termination payments and benefits that meet all of the following criteria.
- the payments or benefits fall under section 401(1)(a) ITEPA 2003 (ie they are received directly, or indirectly in consideration or in consequence of, or otherwise in connection with the termination of a person’s employment)
- the payment or benefits are made on or after 6 April 2018
- the employment was terminated on or after 6 April 2018, and
- the payments or benefits are not redundancy payments, or contractual payments, which are exempt under section 309 ITEPA 2003
Termination payments and benefits which meet all of the above criteria are ‘relevant termination awards’. These are split into two elements:
- Post-employment notice pay (PENP)
This is chargeable to tax as general earnings and does not benefit from the £30,000 tax-free threshold in section 403 ITEPA 2003. Post-employment notice pay is calculated by applying the PENP formula to the total amount of all relevant termination awards received.
- Termination awards subject to section 403 ITEPA 2003
These are chargeable to tax as specific employment income and benefit from the £30,000 tax-free threshold (EIM13505). These termination awards are calculated by subtracting the amount of PENP from the total amount of all relevant termination awards received.
Example 1
Step 1 is to calculate the employee’s basic pay ignoring overtime, commission and bonuses for the 12 months before the last day of employment (say £24,000 pa)
Step 2 is to calculate the number of days in the notice period which the employee should have worked if the employment was not terminated by the employer (say 20 days).
The taxable Payment in Lieu of Notice (PILON) is £24,000 x 20/365 = £1,315
This amount of £1,315 is treated as general earnings, in the normal way, and PAYE and employer’s and employee’s National Insurance is due on this amount.
If the actual compensation awarded to the employee by the employer was say £4,000, then the remainder of £2,685 (£4,000 – £1,315) is treated as a termination payment under section 403 ITEPA 2003. As this is less than £30,000 that amount of £2,685 would be paid tax free to the employee.
Some employee remuneration packages are more complex and may include salary sacrifice arrangements long notice periods etc. The new legislation includes a formula which is designed to cover all situations. This formula applies to the simple situations demonstrated in example 1 above and to the more complex situation illustrated in example 2 below.
Example 2
Mr Smith is a monthly paid employee on a salary of £90,000 per annum (£7,500 per month). On 7 June 2018 his employer tells Mr Smith that his employment will be terminated and he is given three months’ notice as required by his employment contract, and the employer agrees to pay Mr Smith £40,000 compensation. On 1 August 2018 the employer tells Mr Smith that his services will not be required with immediate effect and Mr Smith is paid £16,000 as a Payment in Lieu of Notice (PILON) which was not required under the contract of employment. Mr Smith was not entitled to a statutory redundancy payment.
Calculate the Post-Employment Notice Pay = [(BP x D)/P] – T
BP = the employee’s ‘basic pay’ from the employment in respect of the last ‘pay
period’ to end before the ‘trigger date’.
P = the number of days in that pay period
D = the number of days in the ‘post-employment notice period’
T = the total amount of any payments or benefits received in connection with the termination which are already taxable as earnings apart from these provisions, but not including any bonus payable for the termination or any pay in respect of holiday entitlement for a period before the employment ends.
BP = £7,500 (basic pay for the last monthly pay period ended before 7 June 2018
P = 31 = number of days in that pay period
D = 36 = number of dates from 2 August 2018 to 6 September 2018 inclusive
T = Nil
Salary covering the period 7 June to 1 August taxed in the normal way.
Post-Employment Notice Pay = £7,500 x 36/31 – 0 = £8,710
The Post-Employment Notice Pay of £8,710 is less than the total termination awards of £56,000 (£40,000 plus £16,000), therefore £8,710 is treated as taken out of the special provisions and into the charge on general earnings. The balance of the termination awards is £47,290 (£56,000 less £8,710) and this is taxable under the special provisions and subject to the £30,000 exemption.
Therefore £8,710 is taxable as earnings and £17,290 (£47,290 – £30,000) is taxable under the special provisions.
£8,710 is liable to employer and employee Class 1 NICs
£17,290 is liable to employer Class 1A NICs
Trigger date is 7 July 2018
HMRC Employment Income Manual EIM12800 contains details on ‘termination payments and benefits’.
The new rules effective from 6 April 2018 are due to be in EIM12982 to EIM12992 although at the time of writing this article these were not available.
National insurance contributions
An amount of payments and benefits within the charge to income tax under the special provisions (disregarding the £30,000 threshold) is not currently subject to either employer NICs. From 6 April 2019 onwards, under legislation to be included in a 2018 National Insurance Contributions Bill, any excess over the £30,000 threshold will be liable to employer Class 1A NICs. The exemption for employer NICs on the first £30,000 and the exemption that this Class 1A charge will be payable to HMRC in ‘real-time’ (rather than after the end of the tax year) by being included as part of the employer’s standard payroll returns and remittances.
With effect from 6 April 2018 the rules should apply as detailed here
ACCA factsheets
ACCA has a suite of employment factsheets including these two:
Article from ACCA In Practice