The government has recently cut back their initial, quite radical, proposed changes to the way termination payments are taxed. They have instead, more recently, issued new draft legislation, which represents comparatively milder proposed changes. The draft legislation is titled “Simplification of the tax and National Insurance treatment of termination payments: government response and consultation on draft legislation”.
In short, their new proposed legislation maintains the current £30,000 income tax exemption for non-contractual termination payments, as the purpose of this payment is to compensate employees for their loss of employment. Non-contractual termination payments include redundancy payments as well as awards for unfair dismissal by an employer. Conversely, contractual payments at termination, which include holiday pay and salary are considered “general earnings” and are therefore fully taxable by the government.
The proposed changes by the UK government will make all PILON (payment in lieu of notice) amounts taxable, regardless of if a worker has a contractual right to a PILON payment or not. As it stands, workers that have contractual rights to PILON payments are taxed, whilst non-contractual PILON payments can qualify for the £30,000 exemption that was mentioned above.
The proposed changes mean that employers will also have to pay NI contributions on non-contractual termination payments that are higher than the £30,000 exemption whereas currently they only pay income tax and are free from employer and employee national insurance contributions.
Currently there are several exemptions and reliefs that do apply to termination payments in addition to the £30,000 threshold. These exemptions attract no income tax liability even if they are over the £30,000 threshold. The exemptions include payments made because of death, disability or injury of the employee.
However, the new draft legislation proposes that “injury of feeling” not be exempt in this same category. HMRC has stated “the exemption does not apply in cases of injured feelings” and that the exemption only applies if there is an “injury or disability of a physical or psychological natural that is sufficient to cause the employee to be unable to perform his or her job properly”.
Finally, another key change outlined in the new draft legislation is the abolishment of “Foreign Service Relief” from April 2018. The way things stand now is that the relief allows termination payments for qualifying employees to be completely exempt from any income tax. The relief applies to workers who obtain termination payments whilst working in the United Kingdom but have worked for their employer in a country other
than the United Kingdom for more than 75% of their employment time over the last 20 years. It is crucial to note however, that a smaller proportion of relief may apply to individuals who do not meet the criteria for full deduction.
This new draft legislation is quite a big step back from the governments initial more radical plans to reform the tax treatment of termination payments. The dialling back in this new draft legislation is largely a result of feedback they received which informed them that their initial, bigger proposal in 2015 was adding too much unnecessary complexity as it was seeking to eliminate the important distinction between both contractual and non-contractual termination payments as well as trying to tie the tax exemption threshold to length of service.