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On 6 April 2018 the way companies must handle a termination payment has changed. New rules came into effect with the aim of simplifying the tax treatments of any termination payment and to halt a system that the government felt “incentivise employers to manipulate the rules”. We think that there is still some confusion about what employers can and can’t do, so we thought this article would be useful.

The first thing to note is that while the new rules came into effect on the 6th April, termination payments made in 2018/19 will only fall under the new rules if the termination was on or after 6 April 2018, but the previous rules will apply where the date of leaving the employment was 5 April 2018 or earlier. This is regardless of when any actual payment was made.

Under the old rules, where an individual’s employment contract contained a PILON (Payment in Lieu of Notice) clause, any period of notice not worked should have been subject to usual PAYE deductions for tax and National Insurance as it would have constituted earnings from employment. However, where an employee’s contract did not contain a PILON clause, dismissing the employee immediately could have technically be a breach of contract and therefore any sums payable to the employee, up to the £30,000 limit, may have been able to be paid free of any deductions. It is this practice that HMRC wanted to tighten up by closing down the option for employers of removing pay in lieu of notice clauses from employment contracts.

The government have now closed the PILON loophole. HMRC will now treat any payment in lieu of notice, equivalent to an employee’s unworked period of notice, as earnings. Whether the employee has a PILON clause in their contract or not is now irrelevant. Such earnings, calculated at basic pay, will now always be subject to PAYE deductions (tax and NI). Such payments are known as Post Employment Notice Pay or “PENP”.

The PENP calculation is not required if the notice due is worked, or paid for, as the employee is on gardening leave or if there is no termination payment other than taxed items such as a contractual PILON, holiday pay, bonus or untaxed items such as statutory redundancy pay.

Businesses who pay tax free PILONS may feel an increase in costs with the additional PAYE requirements on the same from April 2018. It’s also worth employers looking ahead to the changes in April 2019 and the introduction of payments of employer National Insurance Contributions on termination payments over and above £30,000.
When making payments under settlement agreements, employers should ensure that relevant tax indemnities are included in the agreement. This will assist in recouping any unpaid tax, NICs, penalties and interest should the payments be scrutinised.

The Government have released a report into the new rules which can be found here.

If you’d like to talk to us about any aspect of the rule changes, please get in touch.