The tax treatment of some termination payments has changed. From 5 April 2018, new (more complicated) rules apply to the payments made to employees in lieu of them working out their notice.

Melanie Stancliffe

HMRC made changes to the tax and National Insurance Contribution (NIC) treatment of payments made at the end of employment because employers were manipulating the rules by structuring arrangements to minimise tax deductions.

Payments due under the employee’s contract (for instance holiday pay, bonuses and so on) are generally chargeable to income tax and NICs. An employer paying an employee in lieu of notice under a contractual clause had to tax the payment. However, some employers were not giving notice or were making payments in lieu without any right in the contract and seeking to pay that sum as an ‘ex-gratia’ or ‘termination payment’, without any deduction of tax up to £30,000.

This is because termination payments that are not otherwise taxable enjoy the benefit of a £30,000 income tax exemption (redundancy pay). HMRC wised up to these practices and has sought to tax “disguised” notice payments. Even if the contract did not contain a PILON (payments in lieu of notice) clause, if the employer’s ‘customary’ or ‘automatic’ response to termination was to make a payment instead of the employee working out their notice, HMRC would require tax and NICs to be paid on the part of the ex-gratia payment that equated to notice pay.

For terminations after 5 April 2018, all payments in lieu of notice (whether permitted by the contract or not) will be treated as general earnings and subject to deductions for tax on the full amount. An employee will no longer be able to be paid a tax-free sum equivalent to their notice payrolled up to a £30,000 tax-free amount.

Tax self assessment

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Employers will now need to tax all ‘post-employment notice pay’, even if no notice is given or the employee is allowed to leave before the end of their notice period. Instead of paying a gross payment up to £30,000, the sum the employee should have received for their notice period will now be reduced by tax.

Employees will therefore receive a net sum, rather than the previous gross sum. An employer negotiating settlements with an employee will now have to consider “topping up” that payment, so that the employee receives the level of compensation they would have received prior to the change.

The good news for employers and employees is that redundancy payments and payments for loss of employment will continue to benefit from the £30,000 exemption, as long as there is no disguised notice pay included in them.


However, HMRC has created a category referred to as ‘post-employment notice pay’, which will not be tax free, and employers will need to decide what element of the payment falls into this category.

Despite the aim to bring simplicity, this new approach is far from straightforward. It adds increased cost in the payroll and administration to help process which termination payments benefit from the threshold (£30,000 exemption) and which do not.

Employers will need to understand how HMRC calculates post-employment notice pay in order to determine how the termination payment will be taxed and how much, if any, is subject to PAYE deductions. The calculation is tricky and HMRC will pursue an employer for any under-deduction of PAYE.

The new rules relate to payments where employment ends on or after 5 April 2018. An employee whose employment terminated on 31 March 2018 but who received their termination payment on 6 April 2018 will not be caught by the reform.

This change increases the tax liability on termination payments. HMRC is removing loopholes and adding complexity. It would be helpful if future changes were simpler for businesses and employees.

Melanie Stancliffe is an employment partner at Irwin Mitchell