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Tax on termination payments

Guest blog by Beatrice Maduka CMIIA QIAL CIA | 5 July 2018

In the 2016 Budget it was announced that the government intended to clarify and tighten the rules about the taxation of termination payments. HM Revenue & Customs subsequently published legislation which came into effect from April 2018.

Prior to April 2018, employees could receive the first £30,000 of any termination payment free of Income Tax and National Insurance Contributions (NICs). Payment above this amount being subject to Income Tax, but not NICs. This rule also applies to Pay In Lieu Of Notice (PILON), if PILON is not a contractual employment right.

Several significant changes have been made regarding how Income Tax and NICs will apply to termination payments from April 2018. Here are some of the main changes:

  • All PILON will be treated as earnings; and subject to Income Tax and NICs irrespective of whether a PILON clause is included in the employee’s contract of employment
  • Besides PAYE, termination payments over £30,000 will be subject to employers’ NICs (note: this has been delayed and will now take effect from April 2019)
  • Termination payments assigned to 'injury to feelings' are not covered by the general tax exemption for injury payments. This is with the exception for cases relating to a psychiatric, medical injury or recognised medical condition.

What impact will this have on the organisation?

  • PILON - need for employers to calculate the amount of basic pay that an employee would have received, if they had worked their notice period. This rule also applies where an employee leaves employment part way through their notice period
  • From April 2019 the cost of offering termination packages over £30k will increase for employers as they will be subject to additional NIC charges
  • Updates and changes to systems and procedures.

What can internal audit do?

Provide assurance around:

  • Compliance with changes to tax rules on PILION
  • Accuracy and completeness of the calculations of the total cost of termination packages
  • The accuracy and completeness of the employer’s standard weekly or monthly payroll returns and remittances of tax and NIC payments to HM Revenue and Customs.

Further reading

HMRC: Income Tax and National Insurance contributions: treatment of termination payments

Content reviewed: 1 February 2023