Tax updates for settlement agreements including pay in lieu of notice

There are often changes to the law in April, coinciding with the start of the new financial year. In April 2018, the Government made changes to  the tax treatment of various termination payments that have a direct impact on our clients’ settlements. Nicola Welchman, one of Monaco Solicitors’ experienced solicitors, reviews the recent refinements made to termination payment tax, discussing the changes and their likely impact.

Payment in lieu of notice tax

From 6th April 2018, the Government introduced changes to the tax regime that  affect employees exiting employment under the terms of settlement agreements.  This is likely to affect the ex gratia payment paid to employees on termination of employment. The following changes have been introduced by the Finance Act 2018:

New tax implications on pay in lieu of notice

Previously, the general principle on tax on notice was that if a contract of employment allowed the employer to pay in lieu of notice (PILON) this payment was taxable. However, if a contract of employment did not allow the employer to make a PILON payment, this could be tax-free if the payment (and any other associated compensation) was under £30,000.

From April 2018, the new legislation requires the employer to account for any basic pay that the employee would have received if they had worked their notice.  This basic pay is  treated as earnings and as such is subject to tax and national insurance contributions, even if the contract of employment made no provision for a PILON payment.

This simplifies the approach to the taxation of PILON payments.  Whilst this may be welcome news, there are occasions where a PILON payment will be purely compensation. For example, in a case of constructive dismissal where an employee has left employment immediately without working their notice and without receiving any pay.  Or in cases of wrongful dismissal, where the employer has failed to give the appropriate notice on termination.

As a result, it should remove some ambiguity from termination discussions and should prevent employers from seeking to suggest that they are offering a tax-windfall by terminating employment without adequate notice.

Employer’s national insurance contributions

From April 2018, a termination payment attracts Employer’s National Insurance contributions.  Whilst the Government has tried to spin this as an additional burden on the business rather than the departing employee, we are concerned that  it may reduce the payments that employees receive.

At Monaco Solicitors, we view the change in legislation as disappointing as it fails to align itself with the principles behind making tax free payments to departing employees.  This was not about closing a tax loop hole.  There are many instances where it is quite proper to use damages payments for breach of contract claims and ensure that those payments are tax-free.  Furthermore, the £30,000 tax free payment, sometimes known as the “golden hand shake exemption”, has not changed for 30 years.  If the figures had been uplifted to today’s money, this would mean a tax-free sum of over £70,000. See our former colleague, now MP for Lewisham West and Penge, Ellie Reeves debating this issue in parliament.

Contact our experienced solicitors who can advise you of the changes and how they will affect you.

Injury to feelings

Another thorny issue that the Government has tackled in the Finance Bill, is the question of the treatment of a payment for injuries in discrimination claims. The new legislation has defined a new category of tax exemption. The “Disability Exemption” will apply where an injured employee is compensated for damages resulting from a psychiatric injury that is beyond compensation for hurt feelings. The test is going to be difficult for employees to establish and we foresee appellate courts turning somersaults working out if a person’s disability or injury prevents the employee from carrying out their employment, or whether the inability to work relates to a breakdown in the employment relationship… while some tax barristers will be getting richer.


Next steps

If you want to talk to us about your work situation, including your next steps and whether you deserve a better deal, just get in touch on 020 7717 5259 or request a free consultation, no obligation.