TAX - PAYROLL - 15.03.2018

Employers and the new termination payment rules

New rules for termination pay

New rules, which take effect on 6 April 2018, simplify the taxation of payments in lieu of notice (PILONs). The old rules mean a PILON might or might not be taxable depending on the circumstances. The new rules, on the other hand, say all PILONs and other contractual payments paid when an employee leaves their job, e.g. accrued holiday pay, are taxable as earnings and so liable to PAYE tax and NI.

Bad news for employers

Because most PILONs etc. could be paid tax and NI free under the old rules, employers face a direct extra cost under the new rules, i.e. employers’ NI at 13.8% of the amount paid. There’s also a possible additional cost; where the new rules mean employees lose more of their termination payment in tax and NI, they may push for an increased settlement.

How much pay is taxable?

PILONs and contractual entitlements, e.g. bonuses and holiday pay, are fully taxable under the new rules, but for redundancy pay and compensation for the loss of work they are unchanged. They are only taxable to the extent they exceed £30,000 and not liable to NI at all. Note. The rules for NI on payments above £30,000 were due to come into line with those for tax on 6 April 2018, but this has been put back by one year.

Tip. While the new rules include a tricky formula for working out how much of a termination payment is taxable, there’s a simple alternative in situations where the termination payment is solely made up of contractual pay (see The next step ). For example, you pay an employee a termination payment for a four-week notice period (which they don’t work) and accrued holiday pay, but no more. The whole amount is earnings and PAYE tax and NI applies to it all.

When to use the formula

In any situation where the amount of termination payment isn’t solely for contractual entitlements you must use HMRC’s formula to work out how much is taxable as earnings and how much qualifies for the £30,000 exemption.

Using the formula

First work out the employee’s basic pay figure ignoring overtime, commission and bonuses for the twelve months up to the last day of their employment, i.e. the date you terminated it. Next, find the number of days in the notice period which the employee would have been required to work, had you not terminated their employment, divide that by 365 and multiply it by the first figure.

Example. John worked for Acom for three years. His job is made redundant on 1 May 2018. Acom asks John to leave immediately. His contract provides for four weeks’ notice. Acom pays John £3,000. His basic pay over the previous twelve months was £24,000. The taxable PILON is £1,841, i.e. £24,000 / 365 x 28. Acom can pay the remaining £1,159 tax and NI free.

For details of HMRC’s formula, visit http://tipsandadvice-business.co.uk/download (CD 19.12.03).