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August 26, 2016

Proposed Changes to Termination Payments

The government has published its draft amendments for termination payments as part of a second round of consultations due to close on 5 October 2016.

The new rules will apply from April 2018 and are set to simplify the taxation of termination payments, increase the income tax/National Insurance Contributions (NICs) take, and expand the power of the Treasury.


This revision follows the Office for Tax Simplification’s review of employee benefits and expenses in 2014. Their final report highlighted the uncertainty and confusion that the current termination payments regime can cause for taxpayers.

Two prominent areas of concern relate to (a) the perception that the first £30,000 of a termination payment is automatically exempt, and (b) the difficulty in determining the status of contractual and non-contractual elements of a termination payment following years of evolving HMRC guidance and case law.

The Current Law

Termination payments can be either fully taxable, partially taxable, or wholly exempt from income tax and/or NICs.

Payments that flow from contractual obligations (or that are customary) are treated as earnings and are therefore subject to income tax and NICs as normal. Income tax and NICs will also be payable in full where consideration is received for a restrictive undertaking, e.g. not to take up employment by a competitor within a specified time period.

Payments that are not contractual are not deemed to be earnings. For employees, only payments above the £30,000 threshold are subject to income tax and the entire payment is exempt from Class 1 Primary NICs. For employers, the entire payment is also exempt from Class 1 Secondary NICs.

Further relief is available for periods of foreign service, payments as a result of injury and disability, payments into registered pension schemes, and other criteria.

The Proposed Law

Increased NICs for Employers

Broadly, the proposed law will split termination payments into two types:

Type 1 - Payments that cannot benefit from the £30,000 exemption

Payments in Lieu of Notice (PILONs) and all post-employment income which would be treated as earnings had the employee worked their notice will now be subject to income tax and NIC as normal.

This is aimed at reducing the uncertainty surrounding whether PILONs are subject to tax/NICs.

Type 2 – Payments that can benefit from the £30,000 exemption

Payments that directly relate to termination will, after the first £30,000, be subject to income tax for the employee and Class 1 Secondary NICs for the employer. The entire payment continues to be exempt from Class 1 Primary NICs for the employee.

In effect, this means termination will be subject to more NICs as employers will now be required to pay NICs on amounts exceeding £30,000.

Restricting Relief

Following divergent case law, the government will include previsions to make clear that ‘injured feelings’ do not qualify for relief as a result of injury or disability.

The government will also remove the bulk of foreign service relief on the grounds that such exceptional treatment has become outdated and unnecessary. Seafarers will continue to benefit from this relief, however.

Expansion of Treasury Power

The £30,000 exemption has remained unchanged since it was set in 1988 (the equivalent of approximately £60,000 today).

The proposed rules will also give the Treasury the power to amend this threshold by regulation, however the government has stated it will maintain the current threshold.

Further information on this consultation can be found on the GOV.UK website.

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