Currently, there is a tax distinction drawn between contractual and non-contractual pay in lieu of notice (PILON) payments.
Where the employee has a contractual clause to be paid PILON, the payment is subject to tax and employee Class 1 National Insurance contributions (NICs).
If there isn’t a contractual clause, and the PILON is paid as compensation for loss of employment, the payment is made free from tax and Class 1 NICs up to a maximum of £30,000. Any amount over £30,000 is subject to income tax.
Changes from April 2018
The government will simplify the tax treatment of termination payments from April 2018.
All PILON payments made on or after 6th April 2018, or where employment ends on or after 6th April 2018, will be subject to normal income tax and employee Class 1 NICs deductions regardless of whether there is a contractual clause or not.
Organisations will have to carry out a calculation to split the termination payment in to “post-employment notice pay”, the amount of basic pay the employee will not receive because their employment was ended without full or proper notice being given, and the remaining balance. The “post-employment notice pay” or ‘PENP’ will be taxable as normal whilst the remaining balance is tax-free up to the £30,000 threshold. This is a complicated calculation and HMRC are expected to release detailed guidance on the correct formula to use.
The new rules on taxation will not apply to statutory or non-statutory redundancy payments. These can continue to be made tax-free up to the £30,000 threshold.
The government had intended to make employer NICs payable on all termination payments over £30,000, making termination payments more expensive for organisations. It was thought that these changes would take effect this year, however, this change has now been delayed to April 2019.