Termination Payments – tax changes due in April 2018

Taxation PaymentsThe latest information on changes to the tax and National Insurance treatment of Termination Payments (payments you may make to an employee when they leave), that will be effective April 2018. (updated November 2018).

The Government started a consultation in July 2016 on proposed reforms to the way employees’ termination payments are taxed (e.g. redundancy payments, payments under settlement agreements) after The Office of Tax Simplification concluded that the tax system applying to termination payments was confused and uncertain.

The Government proposed a system that is easier for employers to administer and easier for employees to understand. The current position regarding termination payments is:

  • Any payments that arise from the contract of employment (e.g. a payment in lieu of notice) is subject to Tax and National Insurance Contributions where there is a contractual right to make such a payment.
  • Payments which do not arise from the employment, (e.g. damages) are only liable to income tax on any amounts over £30,000. This includes redundancy and legal settlement agreements payments.

The Government’s original proposals:

  • Redundancy payments that meet the definition of a statutory redundancy would be tax exempt (on a rising scale depending on length of service). This could also include all other payments made in connection with a redundancy – this would include voluntary redundancies.
  • Removing the distinction between contractual and non-contractual termination payments – so all payments made in connection with termination of employment, e.g. payments in lieu of notice, would be treated as earnings and therefore subject to tax and NIC’s.
  • A termination payment made after an employee resigns would be taxable, as would any termination payment at the end of a fixed-term contract.
  • Any tax free payments would become taxable and liable to NIC’s if the employee is re-engaged to do a similar job at the same company within a 12 month period.

Originally it was believed that the tax free threshold would be less than the existing £30,000 (the consultation document suggests £6,000 as the basic limit, rising with each year’s additional service by £1,000), which for SMEs would make it more difficult and more expensive to negotiate a mutually agreed termination package that is not a redundancy.

Consultation was held in 2015 and 2016 and changes to the proposed legislation have thankfully been made. In the March 2016 budget, the only changes to the taxation of termination payments proposed was the need for Employer NIC’s to be paid on all termination payments over £30,000 (already subject to tax).

The Finance Bills 2017 and 2018 will be effective from 6th April 2018 and the changes to the taxation of termination payments will probably be as follows (we’ll update this if anything changes):

  • Termination payments which benefit from tax and national insurance exemption up to £30,000 will be subject to income tax and Employer Class 1 National Insurance contributions on amounts over £30,000. Employee National Insurance contributions will not need to be paid over £30,000. It was confirmed by the HMRC in November 2017 that termination payments above £30,000 will now only become subject to employers’ NICs from 6th April 2019In November 2018 this changed and payments over £30,000 will only become subject to employers’ NICs from 6th April 2020.
  • All payments made in connection with termination of employment, e.g. payments in lieu of notice, would be treated as earnings and therefore subject to tax and NIC’s. The basic pay that an employee would have received had they worked their notice (rather than be paid in lieu for it) will be subject to tax and NI in full. Basic pay is an employee’s pre-salary sacrifice pay (if applicable) in the pay period prior to the date on which notice is given, or where no notice is given, the date the employment terminates. Basic pay excludes overtime, bonus, commission, allowances, shares and benefits in kind.

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