What do HMRC’s proposed changes to termination payments mean for employers and employees?
Back in July 2015, we reported that the government was launching a consultation on ways to simplify the tax treatment of termination payments – find our article here.
Last week HMRC published draft legislation which could result in changes to how termination payments made to employees are taxed.
So, what are the proposed changes? Below we set out the three main reforms in this area:
- Currently, employees with contractual rights to PILONs (payments in lieu of notice) are taxed at the rate which their salary is subject to, while those employees who do not have a contractual right can receive this payment free of tax (up to the £30,000 exemption). This will change under the proposed legislation so that all PILONs will be taxable, irrespective of whether they are contractual or not.
- Employers will be required to pay national insurance contributions on sums over £30,000. These are not currently payable by the employer under the existing system. However, termination payments will remain free of employee national insurance contributions.
- Crucially, the draft legislation will ensure payments for injury to feelings are subject to tax. To date case law in this area has been inconsistent at best and there are conflicting judicial authorities. The draft legislation clarifies the position by stating that tax free payments in respect of injury or disability may only be made in respect of an injury of a physical or psychological nature which means that the employee is not able to perform their job properly. Financial recompense which does not amount to ‘physical or psychological injury’ but mild embarrassment and the like will now be subject to tax.
These changes (amongst others) are due to come into force in April 2018. Whether they will be a positive step to a fairer taxation system or conversely, an unnecessary change to a well-oiled machine is yet to be seen. There is little doubt that before the changes to the taxation system of termination payment’s fate is decided, many will have their say; the precise wording of the draft legislation is open for consultation until 5 October.