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This publication is available at https://www.gov.uk/government/publications/income-tax-and-national-insurance-contributions-treatment-of-termination-payments/income-tax-and-national-insurance-contributions-treatment-of-termination-payments
Who is likely to be affected
Employers who make termination payments and employees who receive termination payments.
General description of the measure
The measure aligns the rules for tax and secondary National Insurance contributions (employer (NICs)) by making an employer liable to pay NICs on termination payments they make to their employees. An employer will be required to pay NICs on any part of a termination payment that exceeds the £30,000 threshold. It is anticipated that this will be collected in ‘real-time’, as part of the employer’s standard weekly or monthly payroll returns and remittances to HM Revenue and Customs (HMRC).
In addition, the measure clarifies the scope of the exemption for termination payments through a number of changes. All payments in lieu of notice (PILONs) will be both taxable and subject to Class 1 NICs. The legislation requires the employer to identify the amount of basic pay that the employee would have received if they had worked their notice period, even if the employee leaves the employment part way through their notice period. The amount will be treated as earnings and will not be subject to the £30,000 Income Tax exemption. All other termination payments will be included within the scope of the £30,000 termination payments exemption.
The measure also makes changes to certain exemptions in the termination payments legislation. It removes foreign service relief and clarifies that the exemption for injury does not apply in cases of injured feelings.
The current rules for taxation of termination payments are complex and the exemptions incentivise employers to manipulate the rules by structuring arrangements to include payments that are ordinarily taxable to minimise the Income Tax and National Insurance due.
This measure is intended to bring fairness and clarity to the taxation of termination payments by making it clear that all PILONs, rather than just contractual PILONs, are taxable earnings. All employees will pay tax and Class 1 NICs on the amount of basic pay that they would have received if they had worked their notice in full, even if they are not paid a contractual PILON. This means the tax and NICs consequences are the same for everyone and it is no longer dependent on how the employment contract is drafted or whether payments are structured in some other form, such as damages.
The existing £30,000 Income Tax exemption will be retained and employees will continue to benefit from an unlimited employee NICs exemption for payments associated with the termination of employment. This will ensure that those who lose their job will be supported through the tax system.
Background to the measure
At Budget 2016, the government announced that from April 2018, it will tighten the scope of the exemption to prevent manipulation and align the rules so employer NICs are due on those payments above £30,000 which are already subject to Income Tax.
The government held a technical consultation on the draft Income Tax legislation from 9 August 2016 to 4 October 2016. Following that consultation, the government made a number of changes to the proposals to make the rules easier for employers to operate. These changes include requiring the employer to calculate post-employment notice pay on the basis of basic pay only, and removing the requirement to calculate an employee’s expected bonus income and treat that as earnings.
The measure will have effect from 6 April 2018.
The termination payments legislation is contained within Chapter 3 of Part 6 of the Income Tax (Earnings and Pensions) Act (ITEPA) 2003. There is currently no corresponding NICs legislation to Chapter 3 of Part 6.
Legislation will be introduced in Finance Bill 2017 to amend Chapter 3, Part 6 of ITEPA 2003. The key changes to create the concept of post-employment notice pay are achieved by inserting a number of new sections.
The legislation splits an employee’s termination payment into two types of payment: payments that can still benefit from the £30,000 threshold and those that cannot. The legislation works by first identifying any payments that should be treated as earnings and any remainder is then subject to the £30,000 exemption.
The legislation ensures that statutory redundancy payments remain exempt from Income Tax up to the £30,000 threshold.
Foreign service relief is removed through amendment to sections 413 and 414 of ITEPA. It is retained for seafarers.
A new power to vary the threshold upwards or downwards is also provided.
The employer NICs charge on termination payments over £30,000 is achieved through amendment to section 10 of the Social Security Contributions and Benefits Act 1992. The amendment specifies that a Class 1A charge will apply to termination payments that count as employment income under section 403 ITEPA, provided the earner also pays Income Tax on that termination payment.
This legislation does not set out the way that the Class 1A charge will be collected as this will be covered in secondary legislation in due course. It is anticipated that this Class 1A charge will arise and be paid in ‘real-time’, rather than after the end of the tax year, as with other Class 1A charges.
Summary of impacts
Exchequer impact (£m)
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These figures are set out in table 2.1 of Budget 2016 as ‘Removing employer tax advantage of different forms of remuneration: pay-offs over £30,000’, and have been certified by the Office for Budget Responsibility. More details can be found in the policy costings document published alongside Budget 2016. There will be revisions to these figures which will be set out in table 2.2 of Budget 2017.
This measure is not expected to have any significant macroeconomic impacts.
The additional cost to employers is expected to be reflected in lower wages and profit margins, with a reduction in total wages and salaries of 0.1 % by 2020 to 2021.
Impact on individuals, households and families
There is not expected to be any significant impact on individuals or households.
The change is not expected to impact on family formation, stability or breakdown.
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 on people who are employed. It will have a greater impact on men as their earnings are usually greater than women.
Impact on business including civil society organisations
This measure will have no ongoing impact on compliant businesses and civil society organisations who already apply the rules regarding taxation of termination payments correctly. It will only impact on businesses that structure termination payments to reduce the tax and NICs due. All employers will be required to pay employer NICs on payments above the £30,000 threshold that are not subject to an exemption.
Operational impact (£m) (HMRC or other)
Changes will be required to HMRC’s Information Technology systems to support implementation of this measure. These costs are currently estimated at between £1 million and £1.5 million.
Other impacts have been considered and none has been identified.
Monitoring and evaluation
This measure will be monitored through information collected from tax receipts and communication with affected taxpayer groups.
If you have any questions about this change, please contact the Employment Income Policy team on Telephone: 03000 521589 or email: firstname.lastname@example.org.