Making a termination payment as part of a settlement agreement is a common way of terminating a contract of employment without an employer facing the risk of a claim from the employee. (For more information regarding settlement agreements please click here) Such payments usually include a payment in respect of the employee’s notice period and for many years the way in which payments in lieu of notice (PILON) which form part of a termination payment were taxed differed depending on whether they were contractual or non-contractual. This changed on 6th April 2018.
For termination payments where the termination of employment occurred before 6th April 2018 the tax treatment of a PILON depended on whether the contract of employment gave the employer the right to make a PILON rather than allow the employee to work notice. If the employer had the contractual right to make a PILON then it was a payment which could not be included in the £30,000 tax-free allowance which applies to termination payments and was subject to deductions for income tax and national insurance contributions. If the contract of employment did not give the employer a right to make a PILON then the employer was technically acting in breach of contract by making a PILON, and that payment could be included within the £30,000 tax-free allowance and could be paid free of deductions for income tax and national insurance contributions.
This created an anomaly with regard to payments. Some employees could be paid for a notice period tax free whereas others paid tax.
From 6th April the law changed, the distinction between contractual and non-contractual PILON payments is removed, and all PILON payments will be taxable and may not be included within the £30,000 tax-free allowance. This includes partial PILON payments, where the employee works part of their notice and receives a PILON payment for the remainder.
This could have the effect of making a proposed PILON payment less attractive to some employees than was previously the case. The removal of the ability to pay notice free of tax in some circumstances will reduce the amount paid to an employee.
From 6 April 2019 there will be a further change in that payments above the £30,000 tax free allowance will attract employer national insurance contributions as well as income tax.
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