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Changes to tax treatment of termination payments will be 'expensive' for some employers, says expert


Proposed changes to the tax treatment of termination payments in the UK are not as radical as originally feared, but will still be expensive for many employers, an expert has said.

Draft legislation published by HM Revenue and Customs (HMRC) would essentially remove the distinction between contractual and non-contractual payments in lieu of notice (PILONs) in order to "prevent manipulation" of the rules. The existing tax allowance on the first £30,000 of a termination payment will remain in place, although employer National Insurance contributions (NICs) will now be due on the amount above £30,000 as well as income tax.

The changes were announced as part of the 2016 Budget and are expected to come into force in April 2018, according to the draft legislation, consultation on which closes on 5 October 2016.

Employment tax expert Chris Thomas of Pinsent Masons, the law firm behind Out-Law.com, said that although the proposed changes would "not exactly be welcomed by employers", there would be "relief that it is better than it could have been".

"Certainly, the imposition of tax and NICs on non-contractual PILONs will substantially increase the tax bill on many smaller settlement packages, and the removal of the NICs exemption on payments over the £30,000 threshold will have the same effect for larger settlements," he said. "This will, therefore, be an expensive change for many employers."

"However, the new regime is at least simpler – the original proposal to differentiate between different types of termination and length of service has thankfully been dropped. Some valuable reliefs have also been maintained, such as exemption for payments on disability and for legal costs – and the £30,000 exemption has also escaped unscathed. Overall, therefore, this is probably about as good an outcome as could reasonably have been expected," he said.

The first £30,000 of a payment which is paid in connection with the termination of employment is tax free, as long as it is not otherwise taxable as earnings. Any excess over £30,000 is subject to income tax as normal, but is not currently subject to any NICs. This is due to change from April 2018, when employer but not employee NICs will also be payable on the amount over £30,000, according to the consultation.

All PILONs, including those not provided for in the contract, would become fully taxable according to the draft legislation, in the same way as any other payment which is provided for under the employment contract. Currently, non-contractual PILONs are subject to the special rules that apply to other termination payments which aren't 'earnings' for employment tax purposes. The government said that the current rules were capable of manipulation by employers, who could reduce their tax exposure by "effectively turn[ing] a contractual payment into a non-contractual payment of damages", for example for breach of the employment contract.

The government has confirmed that it will retain some of the reliefs taking some payments outside of the tax regime altogether, for example pension payments, death benefits and the exemption for termination for injury or disability. However, it will abolish the relief for payments made in respect of foreign service.

In a separate consultation, HMRC has proposed removing the tax advantages of providing certain benefits-in-kind to employees through salary sacrifice arrangements in order to address the government's "concern about the rising costs" of these schemes. However, the tax advantaged position of pension saving, cycle to work, childcare vouchers and other "benefits that the government specifically wants to encourage employers to provide" will not be affected, according to a consultation which closes on 19 October 2016.

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