Tax On Termination Payments: The New Law In Practice

In April 2018, the new regime relating to the tax treatment of certain payments made on termination of employment (in particular, payments in lieu of notice (PILONs)) came into effect. Although the new rules were introduced as part of a tax simplification drive, they have nonetheless given rise to several areas of uncertainty.

Background

In broad terms, the intention of the new law was to ensure that all PILONs (whether such provisions are contractual or not) are taxable earnings and subject to income tax, PAYE and NICs. Under the new regime, 'relevant termination awards' are effectively split between:

amounts to be treated as taxable 'post-employment notice pay' (PENP); and amounts which can benefit from the usual £30,000 tax exemption for certain termination payments. Relevant termination awards do not include payments and benefits which are chargeable to tax by other provisions in the ITEPA 2003 outside of Chapter 3; therefore, for example, contractual PILONs continue to be fully taxable as general earnings under ITEPA 2003 s 62. The formula for calculating the PENP differs depending, amongst other things, on whether the employee is paid monthly or not, but for a monthly-paid employee the simplified calculation is as follows:

PENP = BP x D - T

where:

BP is the basic pay for the last pay period to end before the trigger date;

D is the number of months in the 'post-employment notice period'; and

T is any payment or benefit received in connection with the termination of the person's employment which is chargeable to tax as earnings (e.g. a contractual PILON).

So, for example, for an employee on a salary of £30,000 who is paid monthly and has a three month notice period (with no contractual PILON) the calculation would be:

PENP = BP (i.e. £2,500) x D (3) - T (i.e. nil) = £7,500

Can the parties agree a shorter notice period?

The amount which is subject to the PENP calculation is determined by reference to the 'minimum notice' required to be given by the employer to terminate the employee's employment by notice. This is effectively the greater of the notice period required by statute (i.e. the Employment Rights Act 1996) or the employment contract. If, for example, an employee had a relatively long notice period (e.g. 12 months), would it be possible for the parties to agree on or shortly prior to termination that this was reduced to a notice period that was shorter but still above the statutory minimum (e.g. three months) and thereby reduce the amount subject to the PENP calculation? This would seem unlikely in practice.

To begin with, ITEPA 2003 s 402D(11) is effectively an anti-avoidance rule applying where the purpose of certain arrangements is to cause the PENP to be less than it would otherwise have been. Unless the change had been made for reasons unconnected with the termination (and preferably some time before termination), there is a real risk that the changes would be caught by those anti-avoidance...