There are three major changes to termination payments expected over the next 15 months which will affect employees and employers.
From 6 April 2018:
- Foreign service relief will no longer be available for employees who are resident in the UK on termination
- Income tax, and Class 1 NIC for employees and employers, will be due on all payments in lieu of notice.
From April 2019:
- Class 1As will be introduced for the employer on non-contractual termination payments over £30,000
Foreign Service Relief
Foreign service relief applies when an employee who has worked abroad for some or all of their contract receives a non-contractual termination payment. Under current rules, this payment can be either totally or partially exempt from UK income tax, depending on the amount of time that the employee has worked overseas.
What is changing?
From April 2018, foreign service relief is being restricted. Employees who are resident in the UK in the tax year that the termination payment is received will no longer be able to claim any exemption for time worked overseas.
The new rules will apply where the date of termination is on or after 6 April 2018 and any payments or benefits are provided after 13 September 2017. This means that where the employee has foreign service and termination is expected after April 2018, it is not possible to accelerate payments to try to bank any potential foreign service relief and avoid the new rules. Instead both the termination and payment need to occur on or prior to 5 April 2018 for the existing relief to apply.
The taxation of termination payments is already notoriously complex and employers may struggle with this new restriction as it requires the determination of the employee’s residence for tax purposes at the time of payment. Since residence is dependent on day counting it is not always possible to determine an individual’s residence for tax purposes until after the end of the tax year.
When will foreign service relief still be available?
Employees will still be entitled to foreign service relief on qualifying payments if they are either:
- non-resident in the tax year the employment is terminated
- employed as a seafarer
- receiving a payment following a change in employment duties or earnings, rather than termination of their employment.
Payment in Lieu of Notice (PILON)
Currently any payment in lieu of notice (PILON) on termination which is contractual is subject to income tax and primary Class 1 NIC for the employee, and secondary Class 1 NIC for the employer. However, if the PILON is non-contractual then the £30,000 exemption for non-contractual termination payments is available, which can reduce the income tax charge for the employee and eliminate the NIC charge for both employee and employer.
HMRC often challenge whether or not a PILON is truly non-contractual. From April 2018, the matter will be resolved by ensuring that any element of the termination award, contractual or not, which relates to post-termination notice pay is subject to income tax for the employee and NIC for the employee and employer.
Employers’ National Insurance
Changes to employers’ NIC on termination payments had been expected from April 2018, until in November 2017 it was announced there would be further consultation on the measure. Widespread changes will now not occur until April 2019.
From April 2019, the Government is expected to legislate to charge employers Class 1A NICs on any non-contractual termination payments to the extent that they exceed the £30,000 exemption. This will increase termination costs for employers significantly, adding 13.8% on any chargeable amounts, and may result in employers reducing the value of termination awards which they make to employees.