That is (no longer) the question.

From next year, the rules on taxation of termination payments are changing. Although the legislation is not yet finalised, as we start to approach April 2018 these changes will need to be kept in mind when negotiating exit packages with employees. The curtain will finally fall on the custom of the tax-free payment in lieu of notice, and so with it goes the opportunity to sweeten a departure.

Following consultation and initial draft legislation last year, the updated draft Finance Bill 2017 has recently been published, setting out the changes to taxation of termination payments which are due to come into effect from April 2018.

In an attempt to bring “fairness and clarity to the taxation of termination payments”, the draft Finance Bill removes the distinction between contractual and non-contractual pay in lieu of notice payments, providing that national insurance contributions and tax will be payable on all payments equating to notice pay.

In broad terms, this will mean that where an employee does not work his/her notice and is paid in lieu, all sums equating to the basic pay which they would have received had they worked their notice will be taxable as earnings.  This is the case even if there is no pay in lieu of notice clause in the contract.

This heralds the end of the debate about how to tax such payments, and the need to determine whether there is a contractual pay in lieu of notice clause. The tax and NICs consequences will no longer depend on how the employment contract is drafted or how the payments are structured.

In addition, the legislation:

    • Retains the £30k exemption for termination payments, but provides that Class 1A employer national insurance contributions will be payable above £30,000.  The exemption for employee’s national insurance contributions is retained. Income tax will also continue to be payable above the £30,000 threshold;
    • Makes injury to feelings payments in discrimination cases generally taxable, except where they relate to psychiatric injury or other recognised medical condition.  Currently the general position is that they are taxable if arising from a termination but not otherwise.

The draft Finance Bill 2018 also has something to add in terms of termination tax. The bill effectively abolishes the foreign service relief/exemption for termination payments for any employee (other than a seafarer) who is resident in the UK in the tax year that their employment terminates. This will be a major blow for peripatetic overseas employees who would usually return to the UK prior to their employment ending.

All this means that from next year employers and employees will have more certainty as to how termination payments should be taxed. And lawyers will no longer be able to argue about it. However, it also means that employers may have to pay more to terminate employment. Alternatively, employees will walk away with, in some cases, significantly less in their pocket.

Please get in touch if you would like to discuss any issues.