With the aim of simplifying the system and creating certainty over tax status, HM Revenue and Customs (HMRC) is now consulting on possible changes to the taxation of termination payments. The proposals could include replacing the existing £30,000 exemption from income tax and National Insurance Contributions (NICs) with a new exemption for redundancy payments only which increases proportionately with an employee’s length of service.
Current position and the proposals
At the moment, generally, all elements of a termination payment to which an employee is contractually entitled are subject to income tax and NICs in the usual way. Conversely, no NICs are payable on the elements of a termination payment that are made in connection with termination of employment and such payments are only liable to income tax on the amounts exceeding £30,000. Payments in lieu of notice (PILONs) can be taxable and subject to NICs or tax and NICs free depending on whether there is a PILON clause in the employment contract. Even if there is no PILON clause, some PILONs (known as auto PILONs) may still be taxable if the employer has a policy of making them to leavers. As termination payments are often made up of several different elements, these rules can result in difficulties for employers in determining which parts are taxable and subject to NICs.