Step-by-step: taxation of termination awards
On 6 April 2018, the tax treatment of employment termination payments changed following amendments to the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) made by the Finance Act 2017.
The main difference relates to payments in lieu of notice (PILONs). Previously, if an employment contract included a PILON clause, any PILON was subject to deductions for tax and class 1 NICs. Where there was no contractual right to a PILON, the sum was treated as a damages payment and could be paid tax and NICs free subject to the £30,000 threshold.
Under the new rules, both contractual and non-contractual PILONs are subject to deductions for tax and NICs. The legislation has introduced the concepts of a ‘Relevant Termination Award’ and ‘Post-Employment Notice Pay’ (PENP) and new calculations that can lead to unexpected results.
The changes, which were originally described as a simplification of the rules, are anything but. Our step-by-step guide explains how to determine the tax treatment of a termination payment and turns its attention to some tricky questions.