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Taxing PILONs


It’s been 5 months since the new tax regime for termination payments came into force. James Lynas looks at how the new law is bedding down.


From 6 April 2018 a new regime for tax and class 1 NICS on termination payments came into force. The big change was removing the distinction between contractual and non-contractual notice payments so that all PILONs and damages payments for notice are treated as earnings and this subject to income tax and both employer and employee NICS, without any benefit from the £30,000 exemption.

That description is quite simple – the detailed rules themselves are not. A complex calculation of “Post Employment Notice Pay” for a “Post Employment Notice Period” applies if there is a “relevant termination award” and leads to all salary and allowances that the employee could have earned in their notice period being subjected to income tax and NICS – (known in the jargon as the PENP rules).

In practice over the last 5 months we have identified 3 particular oddities.

Bizarrely, contractual PILONs are not relevant termination awards so are taxed without the need for the complex Post Employment Notice Period calculation. This does not though mean that if an employer exercises a PILON the PENP rules won’t apply. They will be triggered by any other payment (e.g. an ex gratia severance payment). The contractual PILON may specify that it only covers basic salary, but the PENP calculation encompasses “basic pay” that would be have been due if the notice period had been worked. – so for example a car allowance which is always paid alongside salary could be included as “basic pay”. The first part of the ex gratia severance payment would then treated as if it was the car allowance for the notice period and will be subject to tax and NICS and won’t be covered by the £30,000 exemption.

Sometimes settlement agreements are based on a variable termination date with an employee initially working their notice period but being entitled to leave earlier and getting their severance package earlier (if they find another job or if their handover is complete). The effect of the new rules is that if an employee does leave early the first part of the severance payment will be subject to tax for the unworked balance of the notice period, before the £30,000 exemption applies.

Some employees have differential notice periods in their contracts. The PENP rules are based on the notice period the employer would have to give to the employee, not the notice period the employee could give to the employer. This creates the odd situation of an employee working their full notice period in accordance with their contract but any severance payment still be treated under the PENP rules.

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