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Employers currently contemplating or negotiating termination agreements should be aware of changes to the tax regime which will apply for the 2018-19 tax year onwards. The expectation was that these will apply to payments received from 6 April 2018, although we understand that HMRC have advised that the new rules will only apply where the employment terminates on or after 6 April. HMRC have also stated that they are in the process of drafting detailed guidance on the application of the new rules and hope to publish it in the Employment Income Manual before 6 April. Once there is clarity on the date, employers will need to start factoring in the new rules when considering the timing and negotiation of termination payments.

Currently lump sum payments in respect of notice can benefit from the £30,000 tax exemption for termination payments, provided they are not contractual entitlements ('pilons') or 'auto-pilons' (where there is an 'automatic' practice of paying in lieu). The effect of the changes is to fully tax as earnings such part of a termination payment as is deemed to be in respect of unworked notice;  the balance can then benefit from the £30,000 tax exemption.

The amount deemed to be in respect of unworked notice is calculated using 'basic pay', which includes pay that would have been received had it not been salary sacrificed, but excludes overtime pay, bonuses, commission, allowances, benefits in kind etc.  If the employee is paid monthly, and both the notice entitlement and unworked notice are whole numbers of months, then the calculation can be done using monthly pay; otherwise the basic pay amount must be calculated using the daily rate averaged over the last pay period worked. Certain contractual payments which are already fully taxable (such as contractual pilons) are deducted from the deemed unworked notice pay figure so that only the balance (if any) falls to be taxed under the new provision, to avoid double taxation.  The legislation includes anti-avoidance provisions to prevent parties manipulating pay to lead to a lower amount for tax purposes.

The changes also clarify that the tax exemption for payments in respect of death or injury cannot be used to cover injury to feelings (eg for discrimination), save where the injury amounts to a psychiatric injury or other recognised medical condition. Foreign service relief is also abolished for UK resident employees (except in relation to seafarers).

Proposed changes to subject all termination payments above the £30,000 exemption to employer NICs have been delayed until April 2019.

Currently some employers choose not to include a pilon clause in their standard contracts of employment in order to benefit from the tax advantage, even though this could prevent them relying on restrictive covenants if they want to terminate summarily and pay in lieu of notice. This rationale will fall away in April and employers should therefore include a contractual pilon clause in their standard employment contracts from that date. This may avoid the need to carry out the complicated statutory calculation, provided the pilon amount is comfortably more than the amount deemed to be basic pay (including salary sacrifice) for unworked notice.


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