One of the latest consultations released by HMRC is entitled ‘Simplification of the tax and National Insurance treatment of termination payments: government response and consultation on draft legislation’. This is a not a consultation in the true sense of the word, as the decision has already been made that changes will take place. This document seeks views on the legislation that will made the changes work in practice. It is open until 05 October 2016.
In July 2014, the Office of Tax Simplification (OTS) produced their final report on expenses and benefits and concentrated on the complications around the administration of accommodation benefit and termination payments. Just with regard to termination payments, the overriding word was ‘confusion’ in that employers and employees did not really know what was and what was not taxable.
Summer Budget 2015 announced a consultation that was launched on 24 July 2015 entitled ‘Simplification of the Tax and National Insurance Treatment of Termination Payments’ and ran until 16 October 2015. This contained a foreword by the (then) Financial Secretary to the Treasury David Gauke:
‘I want to reform the tax and NICs exemptions for termination payments so that above all else an employee has certainty about the amount of money they will receive when they lose their job. I also think that these proposals can bring about real simplification for businesses in this area of the tax system’
Budget 2016 announced that it would make changes to termination payments and this latest consultation is the response to this 2015 consultation and contains the draft legislation. As you can see, once again, the OTS have impacted the UK payroll profession, even if it has taken a while since the issue was first raised and will take even longer before it is effective.
Payment in lieu of notice (PILONs)
- All PILONs will be treated as earnings and subject to Income Tax and NICs. This removes the ‘complexity’ highlighted by the OTS where, currently, those provided for in the contract are treated as earnings whilst those provided non-contractually can be paid free of tax or NICs
- However, the general distinction between contractual and non-contractual will remain. It is just that PILONs will get the same tax and NICs treatment regardless of whether they were provided for in the contract
- Only payments that are ‘directly related to the termination of employment’ can be paid free of tax and NICs up to the threshold, currently £30,000. The ‘directly related to the termination of employment’ condition ensures that an employer cannot use the tax and NICs exemption where, in fact, the payment would have been earnings if it were not for the termination.
This seems a complicated way of saying that, regardless of whether there is a contractual entitlement to a PILON or not, the tax and NICs treatment will be the same.
The £30,000 threshold
- The £30,000 threshold will stay (even though it has not been inflated since it was introduced in 1988)
- However, Secondary (employer) NICs will be payable where the termination payments exceeds £30,000. This aligns the treatment for Income Tax, where the first £30,000 is exempt with tax payable thereafter
In the 2015 consultation, there was a Government suggestion that that the threshold could be varied, increasing or decreasing it in accordance with the employee’s length of service. For the sake of simplification, thankfully this was not taken forward by Government. However, a new Section 404B is added to the overriding Income Tax (Earnings and Pensions) Act 2003 (ITEPA) legislation that allows for the threshold to be varied in the future. This is simply an insert into the primary legislation to make it easier to vary in the future and is not an indication that it will vary.
Currently, all termination payment are free of NICs and this is the way that it will remain for the employee. Ensuring NICs are payable by the employer does align the tax and NICs treatment somewhat. Though I wonder if this increased employer cost will affect the value of the termination payment that is offered in the first place. That is to say nothing of the fact that we will have to wait and see how this will be accommodated in payroll software – maybe a new NICs category?
Other exempt termination payments
The £30,000 threshold can be increased by a number of different exemptions, reliefs and reductions, as long as the payment is connected to the termination of employment. The 2015 consultation considered whether these exemptions should remain or be subject to some sort of cap.
The Government has decided that the following exemptions will continue to apply for payments made:
- because of the death, disability or injury of the employee
- under a tax exempt pensions scheme
- to a registered pension scheme
- for liabilities and indemnity insurance
- to HM Armed Forces
- by a foreign government
- where the employee has a certain type of foreign service (see below); or
- in respect of certain legal costs
There are no new exemptions added to ITEPA.
The main changes are that general Foreign Service Relief exemptions will be removed in Section 413 of ITEPA, though protection will be made for the provision of relief for seafarers. The consultation on the draft legislation also states the exemption that applies for injury will not apply in cases of injured feelings (unless this injury to feelings amounts to a psychiatric injury or other medical condition). This is amended in Section 406.
The changes will apply from 06 April 2018, i.e. tax year 2018/19, and apply to any payment made on or after this date. This does seem to be plenty of time for the legislation to be inserted into Finance Bill 2017 and, importantly, work on guidance to employers, agents and software developers.
The current system is complicated and frequently requires expert legal advice. To be honest, I don’t really see how the new system makes termination payments any less complicated or obviates the need for employers to seek legal advice!