A PILON is a payment made to an employee when employment is terminated without giving the employee as much notice as he or she is entitled to under the contract, instead of the employee working through a notice period and receiving pay in the normal way. Before today PILONs which were provided for in a contract of employment were subject to income tax and NICs, but non-contractual PILONs were not.
The distinction between contractual and non-contractual PILONs has now been removed for payments made on or after 6 April 2018, where the employment also ended on or after that date. This means that all employees will pay income tax and Class 1 NICs on the amount of basic pay that they would have received if they had worked their notice in full, even if they are not paid a contractual PILON. The payment will also be subject to employer's NICs.
"This means the tax and NICs consequences are the same for everyone and are no longer dependent on how the employment contract is drafted or whether payments are structured in some other form, such as damages," according to a statement issued by HM Revenue & Customs (HMRC).
Tax expert Chris Thomas of Pinsent Masons, the law firm behind Out-Law.com, said: "The new regime represents a significant change for those employers who have not routinely included PILONs in employment contracts. Aside from the significant extra tax cost, there is clearly the potential for the changes to catch out organisations which are not fully up to speed. In particular, the rules on calculating the deemed PILON are unhelpfully complicated for what is supposed to be a simplification. HMRC cannot be expected to show much sympathy given the long lead in time for the new regime, and will undoubtedly have this high on the list for employer compliance reviews."
"It is vital that both HR and payroll teams are properly trained on the new regime, so that they are able to spot when it applies and, importantly, take it into account when negotiating termination packages so that they don’t make promises around net benefits which prove to be unexpectedly expensive," he said.
Also from today, foreign service relief on termination payments will be removed for all UK residents, apart from seafarers. This means that UK residents whose employment ends after 6 April 2018 who receive a payment or benefit in connection with that termination made after 13 September 2017 will not be eligible for tax relief for any period of foreign service as part of that job.
Before today an exemption from income tax could apply to termination payments where the employee worked all or part of the employment period overseas, even if they were UK resident in the tax year in which their employment was terminated.
The government had originally also intended to apply NICs from today to ex gratia termination payments over £30,000 and on sporting testimonials of more than the £100,000 lifetime exemption. However, these changes need to be introduced in social security legislation and so will be contained in the National Insurance Contributions Bill, which has been delayed. These changes will therefore not come into effect until next April.