Proposed laws on employment terminations could cost employers money

The proposals are likely to be welcomed by employers, as the government wants a structured system that will be easier for firms to administer and easier for employees to understand. The existing tax treatment is complex as a lump sum payment often has to be split into several elements, so that the tax and NIC can be calculated.

Broadly, any contractual termination payments to an employee – such as those in lieu of notice and untaken holiday – attract income tax and NICs, while non-contractual ones are typically exempt from tax up to £30,000. Above that threshold, only income tax applies: there is no NIC.

This has long caused difficulties for businesses and leavers alike. Both have often struggled to establish what is contractual and what is not in order to establish exactly how much tax is payable on a termination payment. The net figure is all that really matters to the leaver. If tax is payable at 40 per cent on what looks like an attractive severance payment, he or she will be sorely disappointed.

The proposed changes will remove the distinctions between contractual and non-contractual termination payments, replacing them with simple bandings so that nobody will have to worry about breaking down the total payout into different elements subject to different treatments. The amount that can be paid free of tax will be easier to ascertain.

This will save employers much administration time and reduce dependence on professional advice as far less guidance will be required on the tax treatment of severance payments.

However, changes will probably strike a note of discord with staff, since most are likely to pay more tax upon leaving, particularly those that were not in post for very long. This may lead to employers having to pay more to achieve the same net payment to the leaver.

The tax free maximum looks likely to be lowered to £20,000, with a new graduated scale of relief up to that limit based on length of employment – and there may be no exemption at all for employees with less than two years’ continuous service.

It is likely to make pay in lieu of notice (PILON) clauses more attractive to employers as their obvious advantages are currently offset by the adverse tax effect of using them.

Barry Warne is partner and head of employment law at hlw Keeble Hawson.

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