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LEGAL UPDATE: Termination Payments – What is changing on 6 April 2018?

A new tax regime takes effect from 6 April 2018 in relation to payments in lieu of notice (PILON), alongside other significant changes to the taxation of termination payments. These changes reflect the Government’s stated intention to “tighten and clarify” the income tax treatment of termination payments. In this article we will look at exactly what is changing and how it will affect you.

Current Rules

Termination payments are extremely common today, often utilised by employers as leverage in settlement agreement negotiations. Currently certain payments made to employees as part of a termination payment are tax free up to £30,000. 

So, why do the Government, and in particular HMRC, believe tighter regulation needs to be brought in? The answer relates to PILON. This type of payment, usually found in employment contracts, enables the employer to pay an individual the sum owed for a notice period, without the requirement for the individual to work and be employed during that notice period.

Under the current rules, it became apparent to employers making termination payments that, where an individual’s employment contract contained a PILON clause, any period of notice not worked should be subject to the usual PAYE deductions for tax and National Insurance as it would constitute earnings from employment. However, where an employee’s contract did not contain a PILON clause, dismissing the employee immediately could technically be a breach of contract and therefore any sums payable to the employee, up to the £30,000 limit, may be able to be paid free of any deductions.  

New Rules

The new rules take effect from 6 April 2018. So, what do the new rules entail? 

All PILONs are to be taxable

Under the new tax regime, all PILONs will be treated as earnings for the purposes of income tax and National Insurance liabilities. HMRC has confirmed that these changes will apply where termination payments are made after 6 April 2018 and where the employment is ended on or after this date.

The £30,000 threshold for tax-free compensation

From 6 April 2018 HM Treasury will have the power to make regulations which would vary the level of this tax exemption, which has remained at £30,000 since 1988.  Watch this space for news of any increase to the threshold.

Injury to feelings payments

From 6 April 2018, payments for injury to feelings (typically made in connection with discrimination claims) will fall outside the tax exemption for injury payments, except where the injury amounts to a psychiatric injury or other recognised medical condition.

Foreign service relief

Foreign service relief for UK resident employees will be abolished from 6 April 2018, on the grounds that the current scheme is outdated and unnecessary. Only employees or former employees not resident in the UK for the tax year in which the employment terminates will be eligible for foreign service relief.

National Insurance liability on termination payments above £30,000

From April 2019 all termination payments above £30,000 will be subject to employer National Insurance contributions (but not employee contributions). This proposal was originally planned for implementation in April 2018 but has been pushed back to April 2019. 

What steps should HR be taking now?

  • All HR and payroll teams should be made aware of the upcoming changes prior to the April 2018 deadline. This article by no means attempts to cover every change in the upcoming tax regulations.  All businesses are advised to take specific tax advice to ensure that they stay on the correct side of HMRC.
  • Those employers whose employment contracts do not contain PILON clauses should consider revising them and inserting contractual PILONs. Paying notice monies in damages will cease to be tax efficient and means that the employee ceases to be bound by ongoing contractual obligations such as post-termination restrictive covenants. Further, a contractual PILON can be limited to basic salary only, whereas a damages payment will include loss of benefits – thereby saving the employer money.
  • 3. Consider very carefully when termination payments will be made in 2018. Employers may be negotiating with employees now in relation to termination payments, and the cost to the employer could be significantly higher if the payment is made once the new laws come into force. 

While the new tax legislation will introduce some simplification in this area, there will still be some points of complexity and uncertainty for employers. The overall intention to tighten the tax rules will also in some cases translate into increasing the overall costs of termination packages for exiting employees. Watch this space for any further developments in this area. 

The Government have released a report into the new rules which can be found here.

If you need help and advice in relation to termination payments, please do not hesitate to contact me or the employment team on 0113 350 4030 or at hello@scesolicitors.co.uk.

If you would like to be kept up to date with employment law and dispute resolution updates, please subscribe to our monthly newsletter.


SCE Solicitors is a boutique employment law and dispute resolution practice based in Leeds which advises clients nationwide.  Please note that the information in this blog is to provide information of general interest in a summary manner and should not be construed as individual legal advice. Readers should consult with SCE Solicitors or other professional counsel before acting on the information contained here.

Emma Roberts

Trainee Solicitor at Sce Solicitors Ltd
Emma is a trainee solicitor at SCE Solicitors. Emma commenced her training contract in September 2018 and is currently working in the employment law department assisting director Samira Cakali. Emma also assists in the running of the firm’s myHR service where she can support you in the day-to-day management of your staff.
Emma Roberts

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Emma Roberts

Emma is a trainee solicitor at SCE Solicitors. Emma commenced her training contract in September 2018 and is currently working in the employment law department assisting director Samira Cakali. Emma also assists in the running of the firm’s myHR service where she can support you in the day-to-day management of your staff.

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