The change relates to the national insurance contributions (NICs) football clubs and other businesses employing high-earning employees could be liable for on termination.
Currently, where an employment contract terminates early and a settlement is agreed then the question arises of how to treat the settlement payment for the purposes of tax and NICs.
Late last year, the UK's Upper Tax Tribunal ruled that payments to two footballers for early termination of fixed-term contracts were taxable as termination payments and not as general earnings, even though the contracts envisaged early termination by mutual consent. The decision related to payments made in 2011 to professional footballers Wilson Palacios and Peter Crouch by Tottenham Hotspur Football Club.
In that case, HM Revenue & Customs (HMRC) unsuccessfully argued that the payments made to the players were general ‘earnings from an employment’, subject to income tax and NICs, rather than payments in consequence of the termination of employment which would not have been subject to NICs and of which the first £30,000 would be tax free.
However, since that ruling, changes have been made, and further reforms promised, to the tax rules around termination payments.
Since April this year, income tax has been due on all payments equating to notice pay. Previously, where there was not a contractual 'PILON' (payments in lieu of notice) in a contract, such payments were usually exempt from income tax. The change brought the income tax treatment of these payments into line with the tax treatment of contractual PILONs.
The government had also earlier outlined plans to change the rules on employer NICs due on termination payments too. That change would see employer NICs payable on the excess amount paid in a settlement above the existing £30,000 tax free threshold. Those changes were expected to be introduced in April 2019, but the UK government has now confirmed that the new rules will be effective a year later.
"There are two remaining measures in the draft NICs Bill published on 5 December 2016: reforms to the NICs treatment of termination payments and income from sporting testimonials," the Budget paper (106-page / 2.74MB PDF) said. "The government still intends to legislate for these reforms, which will take effect from April 2020."
Employment law expert Joe McMorrow of Pinsent Masons, the law firm behind Out-Law.com, said football clubs, where it is the default position that players are contracted to clubs on fixed-term deals and earn significant amounts of money, will be among the businesses that will have felt the effects of the recent changes most keenly when agreeing to terminate fixed-term contracts early.
McMorrow said the Tottenham Hotspur case provided clarity on a "long running debate" over whether payments made in relation to the unexpired period of a fixed-term contract should count as the fulfilment of the contractual entitlement to work for a fixed period, or whether it was better described as damages.
He said the distinction in the Tottenham Hotspur case was important because it was fundamental to the amount of tax and NICs that was payable by the club on the payments it had made. Because Tottenham Hotspur were successful in arguing that the payments made to Crouch and Palacios were damages payments, no tax was payable on the first £30,000 and no NICs were payable at all.
"The focus of the debate was flipped upside down in that case," McMorrow said. "Most employers pay settlements far below £30,000 and the debate usually focuses on whether there is a tax free entitlement up to that amount. That is not the case for Premier League footballers where payments often run into the millions of pounds and the importance of the case was the NICs payable on the amount above the £30,000 threshold; the tax treatment of the first £30k was insignificant. However, Tottenham's success in the case seems to have been a short-lived victory in view of the new rules."
According to guidance issued by HMRC, payments in respect of the unexpired period of a fixed-term contract are likely to be fully taxable and subject to NICs as post-employment notice pay (PENP). McMorrow said that any doubt about employer NICs will end when the rules will change from April 2020 as employer NICs will always be payable on the excess paid above the £30,000 exemption. The recent changes have most impact on footballers with fixed-term contracts. Termination payments to other employees at clubs not typically on fixed-term contracts, such as directors, will be caught by the April 2020 changes, so far as employer NICs are concerned.
"Settlement packages where the employee is getting £30,000 or more in an ex gratia damages payment will cost employers more because they will have to pay NICs at 13.8% on the balance over £30,000 – currently NICs are not payable at all on such payments," McMorrow said. "This change will have its biggest impact on sectors where settlements are routinely in excess of £30,000, like football."
"Employers should ensure their payroll departments are ready for the change and consider the wording in their template settlement agreements," he said.