How changes to tax on termination pay could affect employers

Tax on termination pay is set to change in April 2018. Coodes Solicitors Employment Lawyer Philip Sayers explains what it could mean for employers.

In the past, there has been criticism around how businesses and employees are taxed when an employee leaves without having to work their notice. Complaints are often centred around the system being too complicated and, in some instances, employers taking advantage of the situation.

Previously, where contracts did not contain a right for the employer to make a payment in lieu of notice but the employer opted to make one anyway – rather than have the employee work out their notice – the general position was that the payment in lieu could form part of a tax-free £30,000 exemption. In that scenario any restrictive covenants in the employee’s contract would also become nul and void.

The new legislation should mean that that it will be easier to manage the taxes and harder to manipulate. However, these changes will have an effect that employers should be aware of.

How tax on termination pay is set to change

If an employee receives a payment of £30,000 or less as part of their termination pay, then much of that payment is generally exempt from income tax and national insurance contributions but it depends on what elements make up that sum. While this threshold will remain the same after April, there will be a number of other changes.

Firstly, all pay in lieu of notice amounts will be taxable, regardless of whether an employee has a contractual right to this pay or not. This replaces the previous position whereby, in the absence of a payment in lieu clause, notice pay could generally form part of the £30,000 tax exemption.

Any earnings received post-employment, which would have been treated as earnings if that person was still currently employed, will also be taxed. Payments for what is known as ‘injury to feelings’ as compensation for discrimination will also be taxable, whereas the current position is that they are tax free in most scenarios.

In addition to this, foreign service relief will be abolished, meaning that those who have worked abroad will work to the same taxation criteria as if they had worked solely in the UK. This has been abolished as it was seen to be not be indicative of today’s global workforce.

What does that mean for employers?

While the new legislation will mean a simpler termination process, there may be some financial implications.

Terminations, under the new legislation, will likely be at a higher cost to employers as all pay in lieu of notice payments are taxable. Also, employers should be aware that they may have to offer more money to terminated employees as that employee is likely to receive a lower amount due to the tax deducted.

What happens if employers get it wrong?

If tax and/or national insurance contributions on termination pay is incorrect then HRMC will normally deal with the employer as they have responsibility for unpaid tax under PAYE regulations. That means that although the tax in question is largely the employee’s income tax the employer may have to pay it and, if so, the employee will receive a tax credit for it.

In addition, the employer may have to pay penalties on late or inaccurate tax or national insurance contributions. So it is vitally important to insure that any termination pay is properly taxed as subject to the new legislation.

For more information on this or any Employment enquiries contact Philip Sayers, Employment team, Coodes Solicitors on 01872 246200 or philip.sayers@coodes.co.uk