New tax rules that came into effect on 6 April 2018 mean employers are now required to pay income tax and national insurance contributions (NIC’s) on all payments in lieu of notice (“PILONs”).
The new rules are complex but in essence Income tax and class 1 national insurance contributions will be due on the amount of basic pay that an employee would have received if they had worked their full notice period.
The new rules apply where the termination date and payment of the termination payment take place after 6 April 2018.
What does the change to the taxation of PILON mean?
As of 6 April 2018, in any case where an employee is being paid all or part of their notice period in lieu, employers are required to split a "relevant termination award" (RTA) (broadly, an ex gratia payment) between an amount treated as earnings and an amount benefitting from the £30,000 exemption.
The principle is fairly straightforward, however, the legislation provides a complex formula to calculate the sum that should be taxed, known as “post-employment notice pay” (PENP)*. PENP is, broadly, the basic salary an employee would have received during any unworked period of notice less any contractual PILON. PENP is calculated by reference to:
- Basic pay only (before any salary sacrifice), disregarding bonus, overtime, commission, benefits in kind etc.; and
- How much statutory or contractual notice (whichever is longer) the employer is required to give to terminate the employment contract.
PENP is subject to income tax and NICs in full. The balance of the RTA is eligible for the £30,000 tax exemption and full NICs exemption (provided it is an ex gratia payment). Note that a statutory redundancy payment is excluded from the RTA and automatically benefits from the £30,000 exemption.
For example:
An employee’s employment is terminated on 30 June 2018 and is paid in lieu of their 2 month notice period (there is no contractual PILON clause). The employee is paid £6,000 monthly (basic pay). The employer pays £25,000 as an ex gratia payment (including pay in lieu of notice) on termination.
Pre-April 2018, the entire ex gratia payment would have qualified for the £30,000 exemption (since payments in lieu of notice in the absence of a contractual PILON clause could be paid gross as damages).
However, under the new rules, income tax and NICs (both employer and employee) are due on the PENP of £12,000 (£6,000 x 2 months) and the balance of £13,000 would qualify for the £30,000 exemption.
Formulas and working examples
Download a copy of the formulas and some working examples.
What should employers do?
With immediate effect, employers should:
- Calculate whether any part of a relative termination award being paid to an employee is post-employment notice pay and deduct tax and NI contributions as appropriate. It would be useful to do this in advance of any settlement negotiations to ensure the employee knows what they will receive “in their hand” on termination.
- Where employments contracts do not contain a clause giving the employer the express right to pay the employee in lieu of notice, employers should consider revising their contracts to include this. To pay an employee in lieu of notice without the express right to do so is a breach of the employee’s employment contract.
- Review any template Settlement Agreements to ensure that they contain appropriate wording to set out whether any part of a relative termination award is post-employment notice pay.
We would be very happy to assist with a review of your employment contract and/or settlement agreement, please do not hesitate to contact a member of the employment team
