The rules introduce a new approach and reclassify some payments currently benefitting from the £30,000 as earnings (with the result that benefit of the exemption is lost).
The £30,000 exemption will remain; but its scope will be more limited than at present.
Payments made on termination of employment may be taxed either as earnings or as termination payments benefitting from the £30,000 threshold.
This remains the case under the new rules, although the boundary has moved, as has the method for determining whether a payment falls into the earnings camp or the termination payments camp.
Broadly, the approach is to look at the earnings the employee would have received during the notice period – had the employment continued – and compare it to the payments made on termination (adjusting for certain exempt items).
The termination payment is taxed as earnings up to the level of the earnings that the employee would have received had the employment continued, with any excess over this amount taxed as a termination payment benefitting from the £30,000 threshold.
The first stage is to identify the amount of the termination award which does not benefit from the threshold and is taxed as earnings.
This is the termination award excluding redundancy payments or an approved contractual payment, which is no more than the amount that would've been due had a redundancy payment been payable.
The relevant termination award is then compared to the post-employment notice pay to determine the extent to which the termination award is taxed as earnings and the amount, if any, which benefits from the £30,000 exemption.
The calculations can be complex and we can provide help to ensure all elements of the award are dealt with correctly.
The new rules introduce the concept of post-employment notice pay.
This is essentially the benchmark by which termination awards are judged to see what side of the divide they fall.
Basic pay includes overtime, bonuses, commission, gratuities, allowances, amounts received in connection with the termination, amounts treated as earnings and benefits-in-kind taxed as earnings, plus amounts treated as employment income in relation to securities and share options.
To apply the formula correctly, it is important all elements are taken into account. We can help you determine the amount of the post-employment notice pay.
From 6 April 2018, the approach adopted by the new rules is to compare the payments on termination of employment to what the employee would have received if they stayed in the job.
The following rules apply to determine the amount taxed as earnings and that, if any, which benefits from the £30,000 exemption.
Although various alternatives were proposed during the consultation phase, the tax-exempt threshold remains at £30,000.
This is where the relevant termination award is more than the post-employment notice pay, with the excess being treated as a termination payment and taxable only to the extent it exceeds £30,000.
A new class 1A (employer-only) national insurance charge is due to be introduced from 6 April 2019 and will apply to termination awards taxed as termination payments if they exceed the £30,000 threshold.
Paul's employment is terminated on 1 June 2018 without notice. Under the terms of his contract he is entitled to three months' notice. His salary is £60,000 a year.
On the termination of his employment, he receives a non-contractual PILON of £15,000 and a compensation payment for loss of office of £60,000. He also receives statutory redundancy pay of £2,445.
Paul is paid monthly and was paid £5,000 (gross) on 31 May 2018 in respect of May 2018. The post-employment notice period is three months.
The termination award is £77,445 and the relevant termination award is £75,000 (PILON of £15,000 plus compensation for loss of office of £60,000).
Applying the formula, the post-employment notice pay is £15,000 ((£5,000 x 3)/1) – £0).
The relevant termination award (£75,000) is more than the post-employment notice pay (£15,000).
Consequently, £15,000 (equal to the post-employment notice pay) is taxed as general earnings (and liable to class 1 NICs), leaving £60,000 to be taxed which, together with the statutory redundancy pay, is eligible for the £30,000.
£32,445 (the excess above £30,000) is taxed as a termination payment. If the termination had taken place after 6 April 2019, the employer would be liable for class 1A NICs on £32,445.
The new rules are less generous than the current rules and it may be beneficial to terminate an employment before 6 April 2018 rather than just after.
For example, where the employee receives a non-contractual PILON – and where there is no expectation that a PILON will be made – prior to 6 April 2018, the payment will be taxed as a compensation payment and benefit from the £30,000 exemption.
However, from 6 April 2018 it will be taxed as earnings to the extent that the termination award does not exceed the post-employment notice pay.
The post-employment pay can be affected by irregular items, such as overtime or bonus if they are paid in the last pay period. Planning ahead can prevent distortions to the post-employment notice pay.
Looking further ahead, the new employer-only class 1A charge will come into effect from 6 April 2019.
Where a termination award is likely to exceed post-employment notice pay by more than £30,000, it may be beneficial to advance the termination date to before 6 April 2019 to save class 1A NICs.
For further information on Termination Payments, please contact Alan Rolfe on 023 8046 1200.