Update: Taxation of Termination Payments

In a sign that they intend to fully enforce the new rules, HMRC has begun asking housing associations to confirm that they have been fully implementing the new legislation on the taxation of termination payments.

The Changes

From 6 April 2018 several changes were made to the taxation of termination payments, the key one of which related to PILON payments. Previously, employers often determined or agreed (rightly or wrongly) the tax treatment of a PILON payment depending upon whether there was a PILON clause in the employment contract or not, or didn’t identify a notice payment at all and just rolled the notice amount into a global ex gratia figure with an immediate termination date. However now, where a termination payment is made and notice has not been worked in full then, subject to certain exceptions, an amount equal to the period of notice due but not worked has to be taxed. This is regardless of whether there is a PILON clause in the employment contract or not. For more detail on changes to PILON please see our latest Employment Law Brief.

The Government advised that the reason for this change was to avoid situations in which payments could be structured to minimise tax liability. It is consistent with the Government’s wider objectives around tax avoidance and tax evasion. It was also said to be about making the system clearer; for example, there could sometimes be confusion as to whether a PILON clause had been implied into an employment contract and therefore whether it should be subject to tax and this uncertainty has now been removed as the payment will be subject to tax either way.

Action by HMRC

We understand that several housing associations have been approached by HMRC asking them to provide confirmation that they have complied with the rules around taxing termination payments.

Where an association cannot provide such a confirmation, they will be required to make a disclosure of all the termination payments made within the last 4 years. Although the timing and format of the disclosure may be agreed with HMRC, supporting evidence will need to be provided about:

  • the identity of the employees and date their employment ended;
  • the termination payments made to them;
  • details of any errors made on the taxation of these payments, or queries raised by HMRC; and,
  • how the error came about.

Comment

These proactive steps by HMRC are a clear sign it is taking the changes seriously. If an employer receives a letter from HMRC asking them to confirm they are following the new legislation, it is important this is responded to promptly. If you are unsure whether any of the termination payments you have made within the last 4 years have been taxed correctly, in particular relating to PILON payments, you should seek advice as to whether full disclosure will need to be made to HMRC.

If a disclosure is made about previous errors and additional tax is deemed to be due, then it will fall to the employer to pay in the first instance. Employers will need to look at any terms which they agreed with the employee on their departure as to whether there is the benefit of indemnity protection such that any additional tax, penalties etc can then be recovered from the employee in turn.

Employers should also be aware that further changes affecting termination payments will come into force next year. From 6 April 2019, employers will need to pay national insurance contributions on any portion of termination payments above the £30,000 threshold.

If you have any queries on the above, please contact your usual contact in the Employment and Pensions Team.

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