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Taxation of termination payments: has the dust settled on the treatment of PILONs?

The new rules for the tax and class 1 NICs treatment of termination payments took effect from 6 April 2018. Nearly four months on and, even with the benefit of HMRC guidance, it is fair to say the application of the new rules remains uncertain in many, relatively common, termination scenarios. This blog post is intended to highlight some of the issues causing problems in practice.

How did we get here?

The government embarked on a series of reforms to the tax and NICs treatment of termination payments originally under the simplification banner. While starting out as simplification measures, the new rules “tighten” rather than simplify the tax and NICs treatment of termination payments.

Changes in brief

There are five main changes:

  • Removal of the previous distinction between contractual and non-contractual payments in lieu of notice (PILONs) so that all PILONs are taxed as earnings and subject to class 1 NICs.
  • Subjecting all termination payments above the £30,000 threshold to class 1A NICs (employer liability only).
  • Permitting HM Treasury to vary the £30,000 threshold by regulation.
  • Ensuring that payments for injury to feelings fall outside the exemption for injury payments, except where the injury amounts to a psychiatric injury or other recognised medical condition.
  • Abolishing foreign service relief (except in relation to seafarers) for UK resident employees.

These measures took effect from 6 April 2018 except for the class 1A NICs changes, which will be implemented in a National Insurance Contributions Bill, to be published in 2018, and will take effect from 6 April 2019.

So what’s causing problems in practice?

Of the five changes, it is the new rules for PILONs that are causing the most difficulties in practice. Effectively, employers are required to treat a slice of a termination award (equal to the basic pay the employee would have earned had the employee worked his or her notice in full) as earnings and account to HMRC for tax and class 1 NICs on those earnings in the usual way. For a more detailed explanation of the rules, see Practice note, Taxation of termination payments: Payments in lieu of notice from April 2018 and for a flowchart to guide users through the rules, see Checklist, Taxing payments in lieu of notice from 6 April 2018: flowchart.

That doesn’t sound too difficult …

While the concept of the new rules is relatively straightforward, their application is not. The difficulties arise from various factors:

  • The rules themselves are complex and some key terms are not defined (such as the meaning of “allowance” in the definition of basic pay).
  • Often, the rules are not intuitive. For example, the rules may apply even if a full contractual PILON is paid and taxed. Similarly, the new rules may apply even if the employee resigns and works their full contractual notice, if this is shorter than the notice period their employer would have had to give to dismiss.
  • The rules change long-standing practice. For example, contractual redundancy payments (to the extent they exceed statutory redundancy payments) no longer automatically fall within the £30k exemption.

Is that all?

No. That’s just an example. In fact, we’ve received so many questions about the application of the new rules that we’ve taken many examples of the more common scenarios and posted them as FAQs (see Practice note, Taxation of termination payments from 6 April 2018: FAQs). We would welcome feedback, especially if there are other areas causing difficulties of if there are differences of view on the application of the rules.

Any hope for more HMRC guidance?

We don’t believe so. That said, we understand that practitioners are using the non-statutory clearance process to gain certainty in these matters and this, together with lobbying from professional bodies, might prompt further guidance.

This blog post is the product of collaboration between Practical Law Tax and Practical Law Employment.

Vicki Carr

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