The UK Government has published its response to a consultation on the taxation of termination payments. In 2015, the Government issued a consultation paper containing various different proposals for simplifying the regime. The paper published on 10 August is the Government response and also includes draft legislation for further consultation.

Currently under UK legislation payments and 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 any such payment is tax free and the employers National Insurance Contributions (NICs) are not payable on the whole of the payment. The tax treatment of certain payments, for example payments in lieu of notice (PILONs), will depend on the nature of the payment, including whether it is contractual. There are also various specific exemptions, including for injury, disability or death and for employment performed outside the UK for particularly long periods, known as foreign service relief.

On 10 August 2016, the Government published a paper confirming that it proposes to:

  • Remove the distinction between contractual and non-contractual PILONs. This will mean that all PILONs will be paid subject to income tax, employer NICs and employee NICs regardless of whether or not a contract of employment permits the employer to pay in lieu of notice. In fact contractual PILONs have become increasingly common as including a PILON in the contract ensures that an employer does not commit a breach of contract by early payment on termination. As a result an employer can rely on the post termination restrictive covenants.
  • Retain the exemption from income tax and employers’ and employees NICs for payments relating to the termination, up to the current threshold of £30,000. However, for termination payments over that amount it will align the rules for income tax and employers’ NICs so that employers’ NICs will become payable on the excess over £30,000. This will result in the cost of termination payments being more for employers and may therefore have an effect on the amount that an employer is prepared to pay to an employee.
  • Abolish foreign service relief, except in relation to seafarers. The Government argues that today there is a global workforce and that this exceptional treatment is no longer justifiable.
  • Clarify that the exemption from tax for payments for injury excludes injury to feelings. The exemption will only apply where there is an injury or disability of a physical or psychological nature that is sufficient to cause the employee to be unable to perform his or her job properly.

The Government has not included many of its original proposals, which included only allowing the tax free payments in certain scenarios such as redundancy and changing the level of the tax free exemption from £30,000. This means that the current rules on redundancy payments are not intended to be affected.

The Government has invited views on whether the published draft legislation achieves the stated objective. The consultation is open until 5 October. The changes are intended to come into force with effect from April 2018.

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