Policy paper

Changes to the treatment of termination payments and post-employment notice pay for Income Tax

Updated 29 March 2022

Who is likely to be affected

Employers who make termination payments and employees who receive termination payments.

General description of the measure

The part of a termination payment which is treated as being a payment in respect of the employee’s notice period and subject to income tax and employee’s and employer’s National Insurance contributions is called ‘the Post-Employment Notice Pay’ (PENP).

This measure provides an alternative PENP calculation where an employee’s pay period is defined in months, but their contractual notice period or post-employment notice period is not a whole number of months.

The measure also aligns the tax treatment of PENP for individuals who are non-resident in the year of termination of their UK employment with the treatment for all UK residents. Currently, PENP is not chargeable to UK tax if an employee is non-resident for the tax year in which their employment terminates.

The measure will ensure that non-residents are charged to tax and National Insurance contributions on PENP to the extent that they would have worked in the UK during their notice period. This change only affects individuals who physically performed the duties of their employment in the UK.

Policy objective

The proposed changes to the legislation are intended to remove unintended outcomes and bring fairness and clarity to the current legislation on termination payments, by making it clear that individuals will not receive less favourable tax treatment depending on their contract or residency.

The proposed changes will align the tax treatment of PENP for UK and non-UK resident employees. PENP from UK employment which is in respect of a notice period that would have been worked in the UK will be chargeable for all individuals regardless of where they are resident.

Background to the measure

Changes were made to the taxation of termination payments in Finance (No.2) Act 2017, with effect from April 2018. This included:

• the introduction of PENP to ensure that all contractual, customary and non-contractual payments in lieu of notice are considered and consistently subjected to tax and National Insurance contributions
• the removal of foreign service relief on termination payments to UK resident individuals (this measure did not apply to seafarers)
• clarification that the exemption for injury does not apply in cases of injured feelings
• alignment of the rules for income tax and National Insurance contributions so that employer’s National Insurance contributions will be payable on qualifying termination payments above £30,000. This came into effect on 6 April 2020

Detailed proposal

Operative date

The measure will have effect from 6 April 2021. It will apply to those individuals who have their employment terminated, and where the termination payment is received on or after 6 April 2021.

Since October 2019, HMRC has exercised the managerial discretion available under the Commissioners for Revenue and Customs Act 2005 to provide for an alternative calculation for PENP for use where it is advantageous to the employee. This will continue to apply until 6 April 2021.

Current law

The termination payments legislation is contained within Chapter 3 of Part 6 of the Income Tax (Earnings and Pensions) Act (ITEPA) 2003, section 402D ITEPA 2003, and the legislation on taxable earnings for non-resident employees is contained within Chapter 5 of Part 2, section 27 ITEPA 2003.

Proposed revisions

Legislation will be introduced in Finance Bill 2020-21 to amend the rules on PENP at section 402D ITEPA 2003, and to add provisions in relation to PENP in section 27 ITEPA 2003.

The key changes to the legislation will be to include an alternative calculation for PENP at section 402D ITEPA 2003 for employees who have a pay period defined in months, but a contractual notice period defined in weeks or days, or where the post-employment notice period is not a whole number of months. This will ensure that all employees’ PENP is calculated consistently on the termination of their employment.

The amendment to section 27 ITEPA 2003 will ensure that non-resident individuals are charged to UK tax and National Insurance contributions on PENP, to the extent that their period of notice would have been worked in the UK.

The changes will be published in the Finance Bill 2020-21.

Summary of impacts

Exchequer impact (£ million)

2019 to 2020	2020 to 2021	2021 to 2022	2022 to 2023	2023 to 2024	2024 to 2025
nil	nil	nil	nil	nil	nil

This measure is not expected to have an Exchequer impact.

Economic impact

This measure is not expected to have any significant macroeconomic impacts.

Impact on individuals, households and families

The measure is expected to impact UK based, and non-resident UK employees, who receive PENP. This measure ensures this pay is taxed fairly.

Customer experience is expected to improve as paying tax on termination payments should be simpler.

There is not expected to be any impact on family formation, stability or breakdown.

Equalities impacts

The government has had due regard to equality to comply with section 149 of Equality Act 2010 and relevant Northern Ireland legislation. The proposed measure will impact proportionately on those in groups sharing protected characteristics for people who are employed.

Impact on business including civil society organisations

This measure is expected to have a negligible impact on employers who make termination payments to their employees.

One-off costs will include familiarisation with the changes and could include businesses having to spend time upskilling employees regarding changes to the termination rules. There are not expected to be any continuing costs.

Customer experience is expected to improve as paying tax on termination payments should be simpler. The measure will also clarify and ascertain who should be paying tax regarding Termination Payments.

This measure is not expected to impact civil society organisations.

Operational impact (£ million) (HMRC or other)

There will be negligible HMRC operational impact for this change.

In line with the legislative changes, the guidance regarding termination payments will be updated on GOV.UK.

Other impacts

Other impacts have been considered and none has been identified.

Monitoring and evaluation

The measure will be kept under review through communication with affected taxpayer groups.

Further advice

Find out more about tax on termination payments.

If you would like help with your personal tax circumstances, contact HMRC.

If you have any questions about this policy change, contact the Income Tax Structure and Earnings Team by email: incometax.structure@hmrc.gov.uk.