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Taxation of termination payments - reminder of upcoming changes

All changes are due to take effect from 6 April 2018.

Contractual/non-contractual PILONs

As many will be aware, from 6 April 2018 both contractual and non-contractual payments in lieu of notice (PILONs) will be taxable and subject to Class 1 NICs. Currently only contractual PILONs are treated in this way. This new treatment will apply to all PILON payments which are paid on or after 6 April, where termination has also taken place after 6 April. So, where there is no PILON clause in the relevant employment contract, and an employee is terminated without notice and paid compensation, HMRC will tax the part of that compensation that corresponds to the employee’s contractual entitlements during what would have been their notice period. The remainder of the compensation can still be subject to the £30,000 tax-free “slice”. 

Foreign Service Relief 

Employees who have worked abroad during their employment (for example on secondment to an overseas office) but who are UK resident in the tax year in which their employment terminates will no longer be eligible for foreign service tax relief in respect of the period worked overseas. This affects only a small number of individuals – only around 1,000 people claim foreign service relief a year, and not all of them will be UK resident in their final year of employment. The abolition of this benefit is on the grounds that it is considered outdated and unnecessary by the government. 

Injury to feelings payments 

Injury to feelings payments will fall outside the current exemption for injury payments going forwards, except where the injury to feelings relates to the employee having developed a mental health or other medical condition as a result of the treatment by the employer.  

Employers should be mindful of the above changes when agreeing exit packages or settling claims in the run-up to April. To the extent that any of the above payments are to be made post 6 April, they will be taxed – which drives down the net value of the package for the employee. This may mean that employers end up paying more to counteract this effect, or terminating employment earlier in order to take advantage of the tax treatment in existence pre-6 April.