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Employer National Insurance Deductions on Termination Payments

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I recently wrote a blog on Settlement Agreements entitled “Settlement Agreements-  How do they Work?” In my blog, I discussed the common misconceptions advisors can come across when providing advice on a settlement agreement. One of the issues was the amalgamation of contractual and non-contractual payments.

A payment upon termination of employment normally consists of different elements:

Non-contractual payments - these can either be a redundancy payment, a payment in lieu of notice (PILON) (or, if the contract does not allow such payment, a damages payment) or compensation for breach of contract; and

Contractual payments – i.e. a final salary payment, accrued holiday, and a contractual PILON payment.

To date, it has generally been viewed that the first £30,000 of a non-contractual termination payment can be paid free from deductions of tax and national insurance until now (disclaimer: I am not a tax adviser!). 

Employers may be disappointed to learn that now, whilst payments up to £30,000 will be deemed to be free from tax and employee National Insurance contributions, payments over £30,000 (which are already subject to tax), are also now going to be subject to employer National Insurance deductions.

The reason for these proposals is that the rules governing the taxation of termination payments are deemed to be complex and employers, on occasions, take advantage of the NIC’s exemption by changing the nature of some payments so that they become termination payments.

So what’s the proposal?

From April 2018, the Government is proposing to introduce the following changes:-

  • any payment up to £30,000 will be free from deductions of tax and National Insurance, providing it relates solely to termination of employment;
  • all PILON’s will be subject to tax and National Insurance deductions, even if there is no PILON clause in the contract of employment;
  • the Government will seek to deduct tax and National Insurance from any payment that the employee would have received, had they worked their notice period and finally;
  • employer National Insurance deductions will be made from any payments exceeding £30,000.

How will this affect you as an employer?

Well, there’s good and bad news:

1.    One advantage is that employers can now spend less time considering whether the termination payment is contractual or non-contractual and what the tax payment, if any, will be. Another advantage is that agreements may be finalised fairly quickly on the basis that employers may not receive comments from a lawyer on the other side of the settlement agreement advising that part of the termination payment is taxable and therefore needs to be expressly set out in the agreement.

2.    The disadvantage, however, is that it seems as though many termination payments which go above the new exemption are now subject to employer National Insurance deductions only meaning that the process of settlement agreements could become much more expensive for employers.

This is an interesting proposal from the Government.  Over recent years they have introduced new measures to give employers more flexibility in hiring and firing, the qualifying period for protection from unfair dismissal has been increased from one year to two years, and the concept of a ‘Protected Conversation’ has been introduced. However this latest proposal seems to be counter-productive, making settlement agreements a less attractive (and costly) option for employers. 

Further details of this proposal can be found in the Government’s consultation paper, Simplification of the tax and national insurance treatment of termination payments . Closing date for comments is 5 October 2016 so get your comments in! 

For advice please contact our team.