Terminal tax

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Posted in:HR and Employment|August 24, 2015 | Join the mailing list

The way in which payments made to employees on the termination of their employment are taxed may change in future, as the Government is currently consulting on proposals to simplify the tax regime which applies to such termination payments.

Currently there is a distinction between contractual payments made in lieu of notice where the employer is making use of a clause in the employee’s contract which says that the employer can pay in lieu rather than having the employee work his or her notice
period (a PILON clause), and other payments made on termination, such as redundancy payments, payments to settle potential claims and payments made in lieu of notice but where the employment contract does not contain a PILON clause.

A payment in lieu of notice made pursuant to a PILON clause is currently entirely subject to income tax and also gives rise to obligations in respect of employee and employer national insurance contributions. However, the other types of payments mentioned above
are exempt from both income tax and national insurance up to the first £30,000 and then subject to income tax beyond that. For example, if an employee receives, on the termination of their employment, a statutory redundancy payment of £7,500 and also a payment
settling any employment related claims of £25,000, then he or she will only be liable for tax on the £2,500 which exceeds the £30,000 cap.

The current tax regime can give rise to uncertainty however, for example where the question arises as to whether an employer’s common custom of paying employees in lieu of notice on termination of employment means that the employer’s employees have an implied
PILON clause in their employment contracts, even if there is no express PILON clause.

The Government launched a consultation process on 24 July 2015 in respect of proposals to simplify the tax treatment of termination payments and this process will continue until October 2015, following which the Government will consider the responses and decide
how it wishes to proceed.

Under the Government’s current proposals, all termination payments (with only some limited exceptions) will be subject to income tax and national insurance, but with the first part of the termination payment being exempt from tax and NI where the employee’s
employment is ending because of redundancy and where the employee has at least two years’ service with the employer. The amount of the tax/NI free element is proposed to increase with each additional year of service which the employee has beyond his or her
first two years.

The Government is inviting comments on its proposed reforms and a copy of the Government’s consultation document

is available here.

Responses to the consultation need to be submitted by 16 October 2015.

For more information about any of the above or for practical commercial advice on this or any other aspect of employment law, please contact
Kim Freeman-Smith of the berg Employment team on 0161 833 9211 or email her at

Follow us on Twitter: @Berg_HR

(The information and opinions contained in this article are not intended to be comprehensive, nor to provide legal advice. No responsibility for its accuracy or correctness is assumed by berg or any of its partners or employees. Professional legal advice should
be obtained before taking, or refraining from taking, any action as a result of this article.)


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