As many of you will be aware, the government has proposed some fairly significant changes to the taxation of termination payments, and has recently published a consultation document entitled “Simplification of the tax and national insurance treatment of termination payments: government response and consultation on draft legislation”.
The window for responses to this consultation paper closed last week, and it now remains to be seen whether comments submitted by industry professionals will be reflected when the new legislation comes into force in April 2018.
What is the current position?
As things stand currently, payments and any other benefits “received directly or indirectly in consideration or in consequence of, or otherwise in connection with” a termination of employment are taxable under sections 401 to 416 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003). However, the first £30,000 of such payments are tax free. This legislation only applies to payments that are not chargeable to income tax under any other provision; so if a compensation payment does not fall to be taxed as earnings under Parts 2 to 5 of ITEPA 2003, as consideration for entering into a restrictive covenant or under section 401 of ITEPA 2003, it is not subject to tax.
The tax treatment of the various types of payment that may be made on termination of employment, such as payments in lieu of notice (PILONs), depends on their nature, including whether they are contractual. There are various specific exemptions, including for injury, disability or death, for employment performed outside the UK (the foreign services exemption), and for the armed forces.
What changes are proposed?
The proposed changes, which are due to take effect in April 2018, can be summarised as follows:
- There will be no distinction between contractual and non-contractual payments in lieu of notice (PILONs) (so that all PILONs will be treated as earnings subject to income tax, employer NICs and employee NICs)
- Whilst the exemption from income tax and employers’ and employees NICs for termination payments of up to £30,000 will remain, there will be an alignment of the rules for income tax and employers’ NICs so that employers’ NICs will be payable on payments in excess of £30k;
- Foreign service relief will be abolished (except in relation to seafarers); and
- Payments for injury to feelings will be excluded from the exemption for injury payments (except where there is a psychiatric injury or a recognised medical condition).
Whilst the proposed changes are intended to simplify the current system, the fear is that far from simplifying things, the proposed changes will actually lead to more confusion in what is already a complicated area.
Indeed, there is a real concern amongst some tax professionals that as the legislation becomes even more detailed, employers may simply choose to take the ‘easy way out’, choosing simply to operate PAYE and NICS in full on the total amount of any termination payments made. This means it would be left to the employee to claim any tax relief. If this does happen, it is fair to say that this will merely create more uncertainty for both employers and employees alike.
The reason for this concern is that whilst some of the changes are very specific, they may also be unhelpful. For example, abolishing foreign service relief may well create additional tax liabilities, because the absence of a source for termination payments may mean that double tax treaties are not applicable.
In addition, the new PILON rules will essentially replace established practice and case law, for example under the new rules, departing employees will be taxed up to the end of their notice period on benefits-in-kind (BiK) provided by their employer for which they are being given compensation for leaving early.
It remains to be seen which parts of the draft legislation survive the consultation, but it is clear that when making payments on termination of employment employers will need to carefully consider the tax treatment of those payments.
If you require any assistance in this area, or indeed on any other aspect of employment taxes, please give us a call.