Taxation of termination payments: changes from April 2021

The Government has announced two changes to the post-employment notice pay (PENP) aspects of the termination payment rules which will take effect from April 2021.  These are changes to fix certain unintended outcomes of the existing rules rather than to overhaul any particular aspect of the rules.

Background

The pre-2018 rules governing the taxation of termination payments were seen as complex and in some cases open to manipulation by employers to take advantage of the employer NICs exemption. As a result, following consultation in 2015, the Government introduced fundamental reforms to the taxation of termination payments from April 2018. The main changes included removing the distinction between contractual and non-contractual PILONs (payments in lieu of notice) to treat both as fully taxable earnings, treating all other payments which cover part of the contractual entitlement (including the notice period, even if the employee does not work it) as taxable earnings and levying employer National Insurance Contributions (NICs) on other termination payments above the £30,000 limit.

Amendments to PENP rules

PENP of non-UK resident employees from UK employments is not currently subject to UK tax as earnings.  From 06 April 2021, PENP of non-UK resident employees from UK employments will be subject to UK tax as earnings to the extent the non-UK resident employees would have worked their notice periods in the UK.  This should align the position for UK and non-UK resident employees.

In addition, the current PENP rules operate counter-intuitively in certain circumstances where employees are paid monthly but have notice periods measured in days or weeks or where employees work some but not all of their notice periods.  In some circumstances, this means employees may have non-zero PENP despite receiving a full PILON for their full unworked notice periods.

Since 16 October 2019, published HMRC guidance has allowed employers to use the average number of days in a month (30.42, i.e. 365 ÷ 12) for P (the number of days in an employee's last pay period to end before the trigger date) in the PENP formula rather than the actual number of days in the pay period where the employee's salary is paid by 12 equal monthly instalments and this alternative methodology is in the employee's favour.  This removes the unintended inconsistent outcomes for employees.

From 06 April 2021, this alternative methodology will be placed on a statutory footing.

Further information, including draft legislation, can be found on the Government website.