Since 6 April 2018, employers have been required to pay Income Tax and Class 1 National Insurance Contributions (NICs) on certain parts of termination payments made to employees whether or not these payments are contractual. The element that is liable to taxation is the amount of the termination payment that represents a payment in lieu of notice commonly referred to as 'PILON'. The measure means that all PILONs rather than just contractual PILONs (as was historically the case) are treated as taxable earnings.

In addition, all employees are required to pay Income Tax and Class 1 NICs on the amount of basic pay that they would have received if they had worked their notice in full, even if they are not paid a contractual PILON. This means that the tax and NICs consequences are no longer dependent on how an employment contract is drafted or whether payments are structured in some other form, such as damages.

The changes apply to payments, or benefits received on, or after, 6 April 2018 in circumstances where the employment also ended on, or after, 6 April 2018. Foreign service relief on termination payments has also been removed for all UK residents, apart from seafarers from 6 April 2018.

If an employee is on gardening leave, then the payment for the period to the termination date cannot properly be described as made in lieu of notice as the employment continues to the termination date whether the employee works or not.

Planning note

The introduction of employer NICs on termination payments above £30,000 and on sporting testimonials of more than the £100,000 was delayed until 6 April 2019. All these changes can result in significant extra costs for employers offering significant termination packages.