Sometimes, the dullest looking changes are the most significant. Mention “taxation of termination payments” and many people turn off.

6th  April 2018 saw a change that will affect most employers at one time or another – especially those dealing with settlement agreements or where the employment contract doesn’t include a clause giving them the discretion to pay in lieu of notice (“PILON”).

Prior to the change, employees whose contract didn’t have a PILON clause could often get their notice pay tax free.

In essence, the new rules treat all employment contracts as though they contain a PILON clause, so that the basic pay the employee would have received during the notice period will be taxed as earnings. A statutory formula is used to calculate what part of a termination payment must be treated this way (with the £30,000 exemption remaining potentially available for any balance which is genuine compensation for loss of office). The new rules will apply where both employment is terminated and the termination payment is made on or after 6 April 2018.

Employers will need to ensure they are on top of the new rules, not only to manage the expectation of employees looking to maximise the £30,000 exemption but also to ensure that the formula is applied correctly. This will involve understanding some new terminology, such as the “post-employment notice period”.

In the light of these tax changes, the inclusion of PILONs in employment contracts may become more common, and standard settlement agreement terms dealing with taxation should also be reviewed.

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