Many employers often use Settlement Agreements in order to end an employment relationship on agreed terms. This is a legally binding document and can also be used to resolve ongoing workplace disputes. As a result of signing the agreement, the employee will be unable to make claims in the employment tribunal about any type of claim which is mentioned in the agreement. It can be a useful tool to use, on the back of instigating a “protected conversation”. As this is such a frequently used method of terminating employment, it is important that employers are aware of the changes in the law.
From the beginning of the new financial year (6 April 2018), new rules will be in place for termination payments that are made to employees. HMRC have now clarified that the changes to the tax treatment of payments in lieu of notice made by the Finance (No.2) Act 2017 will have effect only for payments made in, and relating to termination occurring in financial year 2018-2019 and subsequent years. The way in which the payment is taxed will no longer depend on whether there is a payment in lieu of notice clause in the employee’s employment contract.
Some payments and benefits that are made in connection with the termination of employment will be chargeable to income tax and Class 1 National Insurance Contributions as general earnings will not benefit from the £30,000 threshold. As explained above, this change will be applicable to payments or benefits that are received on or after 6th April 2018 in a situation where employment is also terminated on or after that date.
As a way of tightening the treatment of termination payments, the government has introduced post-employment notice pay calculations. This is a sum which calculates the salary that the employee would have received if they had worked the remainder of their notice period.
The legislation has split payments and benefits into two sections:
This is the significant change to the law. Notice pay will now always be taxable as general earnings and will be subject to Class 1 NICs from 6th April 2018, subject to parliamentary approval. The post-employment notice pay is calculated by using a formula set out in the legislation to the total amount of the payment, or benefits paid in connection with the termination of an employment.
The second type of payment is the remaining balance of any termination payment, or benefit, which is not post-employment notice pay. In other words, this would be the non-contractual or ex-gratia element of any compensation paid.
This is taxable as specific employment income where it exceeds £30,000 and is treated in the same way as other payments and benefits taxable under section 403 of the Income Tax (Earnings and Pensions) Act 2003.
In short, the impact of the change is that from April 2018 all notice payments being made under the terms of a contract will be taxable, for both income tax and NICs. It will no longer be possible to ascribe a PILON which does not exceed £30,000 as being an ex gratia payment. This will prevent employers from trying to make severance payments more attractive to employees by deliberately leaving PILON clauses out of contracts of employment, so notice pay could be paid in a more tax friendly manner.
Given that we are almost at the end of the current financial year, it is a more common time for employers to be offering their employee’s settlement agreements. If this is something that you intend to offer your employees, or if you have been offered one by your employer contact us, we can provide specialist advice.