On 6 April 2018 there will be an important change to the way termination payments are taxed. New tax rules, which aim to simplify the taxation of termination payments, will mean that income tax and national insurance contributions (NICs) must be paid on all payments which relate to the notice period. The change will apply to all terminations on or after 6 April.

Termination payments can arise in a number of ways and can generally be described as severance payments made to employees on the termination of their employment—whether that be by reason of redundancy, retirement, or because of a dismissal or constructive dismissal.

On termination, employers need to ensure that tax and NICs are deducted correctly and that any employer NICs—which are calculated by multiplying the earnings or profits plus certain non-cash benefits by the relevant percentage (13.8 percent)—are paid. This is often an important consideration in the context of weighing the cost of settlements and employers will generally be liable for any tax and NICs not deducted, plus interest and penalties.

Currently, employers can avoid taxing notice pay if there is not a ‘payment in lieu of notice’ clause in an employee’s contract or no regular history of making payments in lieu of notice. Technically, the payment is then damages for breach of contract and can be part of the £30,000 tax fee entitlement which applies to noncontractual payments, such as ex-gratia payments received in connection with terminations and redundancies. That will no longer be the case.

The new legislation details how to identify and calculate any payments that should be treated as ‘post-employment notice pay’ to determine the amount of the termination payment that is subject to tax and NICs. The intention is to tax as ‘earnings’ the basic pay the employee would have earned had the employee worked his or her notice. This excludes benefits, bonuses, commissions, allowances, and share options.

By treating all payments relating to the notice period as post-employment notice pay subject to income tax and NICs, the new legislation and accompanying guidance make it clear that in all cases when employees leave without working their notice entitlement, the notice pay due to them will be taxed. It will not be possible to try to structure it otherwise.

A second key change is that employers’ National Insurance will be due on these notice payments and other elements of termination payments that are subject to income tax. In addition, from April 2019, employers’ NICs will be payable on payments above £30,000, which are currently only subject to income tax. Basically, sums that are chargeable to income tax will also be chargeable to employers’ National Insurance.

Other provisions within the legislation include a clarification that payments for injury to feelings will fall outside the exemption for payments for injury or disability unless the injury amounts to either a psychiatric injury or other recognised medical condition.

In addition to the increased liability for NIC payments, one possible consequence for employers is that the changes may result in employees trying to negotiate higher termination payments in order to compensate for what they will lose. HM Revenue & Customs have confirmed that the new legislation applies to terminations made on or after 6 April 2018. Payments made for terminations prior to 6 April 2018 will be subject to the old legislation, even if they are paid after that date.


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