Tag Archive: settlement

Termination payments – changes to the tax treatment

Following its consultation in 2015, the Government has now confirmed the changes which will be made in how termination payments will be taxed, and published draft legislation for comment.

The changes will apply “from April 2018”. It is not clear at this stage whether payments pursuant to settlement agreements entered into before that time will be grandfathered under the existing legislation, but that may well be the case.

Key points are:

  • the existing £30,000 income tax exemption for termination payments will continue to apply, as will the unlimited exemption for employee national insurance contributions (“NICs”) (provided, as now, the payment is not “earnings”). However, employers’ NICs will be due on any termination payment in excess of £30,000, making termination payments more costly for employers;
  • all PILONs will now be taxed (irrespective of whether they are contractual or non-contractual). In fact, any payment or benefit which the employee would have received during his notice period (had he worked it) will be subject to tax and NICs Further details of how this provision will operate in practice are set out below;
  • the exemption for payments due to injury and disability will be retained, but will be amended so that it will not extend to injury to feelings unless the injury amounts to a “psychiatric injury or other recognised medical condition”;
  • foreign service relief will be withdrawn. This may raise some interesting questions, for example, about whether a payment to an employee who has worked outside the UK for several years but for a UK employer, will be caught;
  • the other existing exemptions will remain, including payments made to tax exempt or registered pension schemes, and in respect of legal costs.

PILONs, contractual and non-contractual payments

The intention is that any payment which an employee would have been entitled to receive had they worked their notice period will be subject to tax and NICs and fall outside the £30,000 exemption. Any other (non-contractual) termination payments will continue to benefit from the £30,000 exemption.

The draft legislation works as follows:

  • the employer must calculate the aggregate amount the employee would have been entitled to had he worked for the remainder of his notice period (“PB”). PB is calculated by aggregating the following sums:

(i) “P”: this is essentially the amount of general earnings which would have been earned by the employee during that part of the “minimum notice” period which is not actually worked, calculated by reference to the employee’s earnings for the 12 weeks prior to the end of employment (where no notice to terminate is given) or prior to the giving of notice (where notice is given).  If the full minimum notice period is worked, this number will be zero.  The “minimum notice period” is the minimum notice required to terminate the employee’s employment in accordance with law and his contractual terms.  Anti-avoidance provisions will apply to prevent artificial reduction of earnings during the 12 week testing period; and

(ii)  “B”: this is the amount of any bonus, commission, incentive “and anything similar” that the employee could reasonably be expected to receive before the end of the employment (including during the minimum notice period) and which is not received before the employment ends;

  • if PB exceeds the amount of the termination payment (excluding any payment by way of compensation for unfair dismissal or redundancy), the full termination payment will be taxable.       If PB is less than the amount of the termination payment (after the same exclusions), the amount of PB is taxable, but the excess will attract the £30,000 exemption.


Employee A:

Employee A is made redundant after 15 years’ service. A is required to work the minimum statutory notice period of 12 weeks. A’s gross salary is £28,000 per year and A is entitled to a statutory redundancy payment of £8,400.

During the notice period, A continues to receive salary. This amounts to £6,450 over the 12 week period. This will be subject to tax and NICs as earnings.

When the employment is terminated at the end of the 12 week notice period A receives a total termination package of £17,400 under a settlement agreement, including the statutory redundancy pay.

Tax treatment: Employee A has worked his entire notice period and is receiving a termination payment that is non-contractual. The full payment benefits from the £30,000 exemption and so no tax or NICs arises.

Employee B:

Employee B resigns giving 6 months’ notice as required by his contract of employment. His gross salary is £80,000 per year. He earns commission of (typically) £1,200 per month and receives a car allowance of £800 per month.

He works 8 weeks of his notice period whilst negotiating a settlement agreement with his employer and is paid £12,308 gross salary (8 weeks’ pay), £2,400 commission and  £1,600 car  allowance.

The employer makes a payment in lieu of notice of £27,692 (which is the amount of salary he would have received had he worked the balance of his notice period) and an ex gratia payment of £25,000. In accordance with the terms of his employment contract, the other benefits which Employee B receives in addition to salary are not taken into account for the purposes of calculating the PILON. The full termination payment is therefore £52,692.

Tax treatment: Employee B has not worked his full notice period. Had he continued in employment for the full notice period, he would have received £35,692 (i.e. salary of £27,692 (which is “P” on the “PB” formula), commission of £4,800 and car allowance of £3,200 (which together are “B” in the “PB” formula)).  Accordingly, £35,692 of the termination payment is subject to tax and NICs.  The balance of the termination payment (being £17,000) falls within the £30,000 exemption.  This contrasts with the current law under which the employee would have expected to receive (at least) the full ex gratia payment of £25,000 without tax deductions.

How we can help

Employers need to be aware of the changes and ensure that the correct amount of tax and national insurance contributions are deducted from termination payments since the primary liability for any shortfall is that of the employer.  In addition to advising on employee terminations and settlement agreements, we can assist you in understanding and applying the new rules correctly.   In advance of the legislation being implemented, employers may also want to revisit the notice provisions in employment contracts so that they are consistent with the requirements of the new rules.

For further information,  please contact David Thompson, Nick Hinton or Lynda Finan from our Tax Group.



Permanent link to this article: https://www.dlapiperbeaware.co.uk/termination-payments-changes-to-the-tax-treatment/

Pre-termination discussions: Do recent developments in protection really help employers?

Pattie Walsh, Location Head of our London office, comments:  In July 2013, in the spirit of allowing employers to engage in more open and frank conversations with their employees, the Government introduced a new regime of ‘protected conversations’, preventing certain discussions from being admissible in tribunal proceedings.  On the face of it this employment law reform should have been welcome news for employers. However, in practice, the system is fraught with difficulties opening up the question of whether it has truly added anything to the existing ‘without prejudice’ regime….something which has been reinforced by a recent case potentially extending the ability for employers to rely on the ‘without prejudice’ rule to avoid pre-termination conversations being used as evidence in a tribunal.

The new ‘protected conversation’ provisions have the effect that an employer’s pre-termination negotiations with an employee will be inadmissible as evidence in any subsequent tribunal proceedings relating to unfair dismissal.  The first limitation is immediately obvious – it only applies to  unfair dismissal proceedings. If an employee brings a claim for any other reason (including in relation to an automatically unfair dismissal), the protection does not apply. Protection may also be lost if either party engages in ‘improper’ behaviour – pending any cases on this issue, what constitutes ‘improper behaviour’ is currently full of uncertainty, meaning that employers will have to tread very carefully to ensure they do not inadvertently lose the protection.

The ‘protected conversations’ regime runs alongside the old ‘without prejudice’ principle. This is engaged where there is a dispute between employer and employee and operates to prevent discussions, that are genuinely aimed at settling the dispute, from being admissible in tribunal proceedings.  The potential difficulty with relying on the ‘without prejudice’ principle is identifying whether or not a dispute  has actually arisen. In the past, case law has, for example, established that the raising of a grievance does not necessarily amount to a dispute.  However, other case law has established that there is no need for litigation to have actually been commenced for the ‘without prejudice’ principle to come into play. There has, therefore, been uncertainty about the situations in which it may be relied upon and employers have had to exercise caution and recognise the risk that pre-termination discussions may ultimately end up as evidence. Further, the ‘without prejudice’ principle cannot be relied on if there is ‘unambiguous impropriety’. However, in practice, this is only likely to apply in exceptional circumstances.

Now, another case has come before the EAT which potentially extends the ‘without prejudice’ principle and may provide additional comfort to employers. It may also suggest that employers would be well advised to rely more on the ‘without prejudice’ principle than the ‘protected conversations’ regime.

In Portnykh v Nomura International Plc the EAT held that the ‘without prejudice’ principle should have a broad application. In this case, the employer announced that it intended to dismiss an employee for misconduct. However, following discussions between the parties it was agreed that the employee’s termination would be framed as a redundancy. The parties then began negotiating the terms of the redundancy, but these ultimately broke down. The employee then brought a claim in the employment tribunal and sought to exclude evidence of the pre-termination discussions (unusually, as it is normally the employer who seeks to do this). The employer, however, wished to use the discussions as evidence that the parties had agreed the reason for termination would be redundancy.

The tribunal found that the evidence could be submitted as there was no dispute between the parties. However, the EAT overturned this and said that the ‘factual matrix’ had to be considered. This clearly demonstrated in this case that there was a dispute, or the potential for a future dispute.  The EAT said that there does not need to be existing litigation or a hostile atmosphere. The mere potential for litigation will engage the ‘without prejudice’ principle.

 Although in Portnykh the ‘without prejudice’ principle did not work in the employer’s favour,  there is no doubt that these recent developments in case law and legislation offer employers more comfort than they may previously have enjoyed in relation to pre-termination discussions.   However, both ‘protected conversations’ and the ‘without prejudice’ principle have their limitations – in particular, although the ‘protected conversations’ regime will assist employers in some situations, it fails to really make the mark in practice. Employers would therefore be wise to ensure that any pre-termination conversations are well thought out, and that they always have an eye to the potential risk that what is said and done may ultimately end up as evidence in tribunal litigation.

Permanent link to this article: https://www.dlapiperbeaware.co.uk/pre-termination-discussions-do-recent-developments-in-protection-really-help-employers/