Payment in lieu of notice – to tax or not to tax

The term ‘payment in lieu of notice’ or ‘PILON’ covers a range of payments made on terminating employment.

They are made in a variety of situations and prior to 6 April 2018 had tax implications for employee and employer that need to be considered.

From 6 April 2018 the distinction between contractual, non-contractual, implied, reserved right, customary, automatic, exemption for payments relating to foreign service and other forms of PILON has also been removed. All PILON is now taxable and subject to national insurance contributions.

This should make the calculation of tax and national insurance contributions (NICs) on a termination package much easier, but, as usual, there is always something to complicate matters. It may be that there are benefits attached to the employment contract, or that the employer included a restrictive clause in the contract. These would have be considered separately to ensure compliance with legislation.

So, to ensure that the amount of tax and NICs paid are in line with current legislation below are some of the issues that may need consideration.

Issues under consideration

When calculating the tax and national insurance contributions (NICs) due on a total termination package the following need to be kept in mind

• Any payment(s) must be correctly allocated to the appropriate section of Income Tax (Earnings and Pensions) Act (ITEPA). Some may be wholly or partially exempt from tax and NICs.
• All cash payments chargeable to tax under sections 62, 225 or 393 ITEPA are considered earnings. These sections cover earnings, restrictive undertakings and benefits provided under a non-approved benefits scheme.
• Lump sum payments from an employer-financed benefit scheme may be wholly or partially chargeable to tax (section 394)
• Non-cash benefits may also be chargeable to tax (section 401).
• A payment that falls within section 401 ITEPA is currently not liable to NICs. However, from April 2019 for amounts over £30,000 there may be a charge for employer NICs.
• Amounts over £30,000 will be subject to income tax, and this includes amounts received over more than one year if it is part of the termination package.
• Time spent working abroad is no longer exempt.

Once these points have been considered then the PILON amount can be determined. In an earlier blog the definitions and calculation included in the new rules were outlined. One of the new definitions was the ‘trigger date’.

Trigger date

This term applies from 6 April 2018 and is defined as

“a) if the termination is not a notice case, the last day of the employments, and

b) if the termination is a notice case, the day the notice is given”

The trigger date is used to:

• identify the last pay period
• Establish the ‘earliest termination date’ which then can be used to identify the number of days in the ‘post-employment notice period’, and the amount of PILON due.

Here is an example on how PILON may work in practise.

Once the basic pay is eliminated the rest of the termination payment falls under the £30,000 statutory exemption.

In summary

When calculating PILON or other termination payments the trigger date must be identified in order to ascertain which payments are subject to tax and NICs and which are not. So access to the employment contract, and notice of termination by the employer is of vital importance to avoid any mistakes or repercussions.

And finally, prepare the employer now for the liability for NICs from 6 April 2019. Forewarned means a happy employer.

Julie Hodgskin is a fellow member of AAT, runs a licensed accounting practice and is a technical materials author for CIPP.