Changes to tax on termination pay in April 2018

The Government has cut back proposed changes to taxing termination payments, issuing new draft legislation that is expected to come into force in April 2018.

The proposed legislation keeps the current £30,000 income tax exemption for non-contractual termination payments, which are meant to compensate employees for loss of employment.

Non-contractual termination payments include amounts such as redundancy payments and awards for unfair dismissal.

Contractual payments at termination, such as holiday pay or salary, are considered general earnings and are taxable.

The proposed changes will make all pay in lieu of notice (PILON) amounts taxable, whether or not an employee has a contractual right to a PILON payment.

Currently, employees with contractual rights to PILON payments are taxed, while non-contractual PILON payments can qualify for the £30,000 exemption.

This rule that has been criticised as unfair and as adding unnecessary complexity.

Employers will also be required to pay NIC on non-contractual termination payments above the £30,000 exemption.

Other changes include the removal of the foreign service relief income tax exemption, and a clarification that injury to feeling awards (such as for harassment or discrimination) will not qualify for general injury tax exemptions.

“The Government has significantly dialed back its initial plans to reform tax treatment of termination payments,” said Qian Mou, employment law editor at XpertHR.

“Responses to the 2015 consultation indicated that eliminating the distinction between contractual and non-contractual termination payments, or tying the tax exemption threshold to length of service, would create additional complexity. The latest draft legislation seems to be in large part a response to this feedback.”

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The latest changes were announced with the 2016 budget and are expected to come into effect in April 2018.

The current consultation will run until 5 October 2016.