The way that termination payments are taxed will change from 6 April 2018. The first change to come into effect is to the treatment of pay in lieu of notice payments. At the moment, if an employee is paid in lieu of working their notice when there is no contractual right for the employer to make such a payment it is usually treated as damages for breach of contract and can be paid without deduction of tax up to the £30,000 threshold. This differs from the situation where there is a contractual right to pay in lieu of notice - in that scenario the notice payment is subject to deductions for tax and national insurance contributions.
However, from 6 April all payments in lieu of notice will be treated as earnings and subject to tax and class 1 NIC's irrespective of whether there is a contractual right for the employer to pay in lieu of notice or not. Under a new section of the Income Tax (Earnings and Pensions) Act 2003, any part of a termination payment up to the amount of "post employment notice pay" (PENP) due to the employee will be treated as earnings and subject to deductions. The PENP, broadly speaking, is the amount that the terminated employee would have received had they worked their notice period.
HMRC will usually pursue the employer for unpaid tax and employee NIC's as it is the employer who has the primary responsibility to account for tax and NIC's. While settlement agreements routinely include a tax indemnity allocating the risk of tax to the employee having to rely on such a clause can be problematic. As such, it is important that the correct liabilities are identified and paid at the appropriate time.
A further tax change which was originally intended to also take place in April this year has been put back until next year. From April 2019, any part of a termination payment that exceeds £30,000 will be subject to employer NIC's (as well as being subject to income tax). At present, only income tax is payable on termination payments exceeding £30,000.