Changes to the tax treatment of termination payments

New legislation comes into effect on 6 April 2018 whereby the Government is changing the tax treatment of some termination payments payable when the employment relationship comes to an end.

The legislation follows a previous consultation paper from August 2015 called ‘Simplification of the tax and national insurance treatment of termination payments’.

The main changes are set out as follows:-

  1. All payments in lieu of notice will be treated as income and will be subject to income tax and Class 1 national insurance deductions. The current position is that only contractual payments in lieu of notice are taxable and that any non-contractual payments in lieu of notice that are not made as a matter of custom and practice, can be made tax-free up to the value of £30,000.

    This is on the basis that these non-contractual payments in lieu of notice are treated as damages for breach of contract as opposed to income.    From 6 April 2018, all payments in lieu of notice will be subject to income tax and Class 1 national insurance contributions whether contractual payments or not. The new rules however will not apply if the employment terminates before 6 April 2018 even if the payment is made on or after 6 April 2018.

  1. Foreign service relief will be abolished. Currently foreign service relief allows termination payments for qualifying individuals to be exempt from tax to reflect any overseas periods of employment.
  2. The current exemption from tax for payments to injury and disability will not apply to injury to feelings that are payable on or before the termination date unless that injury is a psychiatric injury or any other recognised medical condition.

The good news however is that the current £30,000 tax exemption and the tax treatment of legal fees payable under the terms of a settlement agreement will remain the same.   It is to be noted that the £30,000 tax exemption however has not increased since 1988 and has remained at the same level and so its real value has diminished over the past thirty years.  This means that genuine compensation payments payable under the terms of a settlement agreement or ACAS Form COT3 which includes any non-statutory redundancy payments should continue to benefit from the exemption.   This is subject to any guidance that might be issued by HMRC in the run up to the implementation of the legislation next month.

The most important change affecting the majority of payments will be those relating to non-contractual payments in lieu of notice.  In some cases the employer will need to calculate how much of any relevant termination award is post termination notice pay.   It would be much easier for employers to keep compensation/termination payments separate from any payments in lieu of notice in any settlement agreements.

It is therefore advisable that employers review their contracts of employment to ensure that they contain contractual payment in lieu of notice provisions as paying notice pay as damages will no longer be a tax-free option.

All contractual payments in lieu of notice are also limited to basic salary whereas any damages payment would include loss of benefits for example pension contributions and bonus payments and having a contract of employment with  contractual payment in lieu of notice provisions will save the employer money.

Further changes are also on the horizon in April 2019 when employers will be required to pay national insurance on all termination payments above the £30,000 tax exemption.  This was also supposed to be implemented in April 2018 but has been delayed.

As ever it is always important to seek timely advice on how these changes will affect you.

Contact Head of Employment Law, Steven Eckett at Meaby&Co for timely advice: seckett@meaby.co.uk or call 0207 703 5034.

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