The forthcoming Finance Act 2017 includes provisions to clarify and tighten the rules on the taxation of Termination Payments. As a result, from April 2018, all payments in lieu of notice (irrespective of whether or not they are contractual) will be subject to income tax and national insurance contributions in full as earnings.
At present, although contractual payments in lieu of notice are subject to deductions, non-contractual payments in lieu of notice can potentially fall within the £30,000 exemption for Termination Payments and not be subject to tax at all. This has proved in some instances to be a useful bargaining chip giving rise to a “win/win” situation for employers and exiting employees alike.
This will change in April 2018 as non-contractual payments in lieu of notice will also be taxable; thus removing the distinction for tax purposes between contractual and non-contractual payments. HMRC’s rationale for the change was that it would simplify the tax treatment of Termination Payments. The practical implication is employers will no longer be able to pay, free of tax, payments in lieu of notice in any circumstance.
However, it is not all doom and gloom. When the new rules were initially proposed the consultation exercise demonstrated that many employers were concerned that the new regime would give rise to an increased complication, namely identifying exactly what the tax amount would be.
In response to this concern, the HMRC revised the legislation to make it clear that the taxable amount in relation to a non-contractual payment in lieu of notice is simply in relation to the employee’s basic pay for their unworked notice period. This means employers will only have to work out the employee’s basic salary for that notice period they do not work and for which they are receiving a payment in lieu in respect of.