Tax and NIC treatment of termination payments: Proposals for simplification
Susan Cattell, Head of Taxation (England and Wales), outlines the ICAS response to the consultation on draft legislation to simplify the treatment of termination payments.
This is the second consultation on proposals to ‘simplify’ the tax and NIC treatment of termination payments. The ICAS response to the first consultation was released last year.
The second consultation covered draft legislation to implement the proposed changes.
The first £30,000 of a termination payment remains exempt from income tax and any payment solely related to the termination also remains exempt from employee NICs.
However, due to proposed changes to the scope of termination payments, some payments which would have been treated as termination payments (and therefore eligible for the £30,000 exemption) will no longer qualify.
All payments in respect of pay in lieu of notice (PILONs) will be taxable and subject to Class 1 NICs; currently some types of PILON fall within the termination payments regime and are eligible for the £30,000 exemption.
Additionally, any payment which the employee would have received if they had worked their notice period will be subject to tax and Class 1 NICs, even if the employee is asked to leave immediately or part way through their notice period.
The draft legislation to implement this will give rise to complex calculations of 'post-employment notice income' and 'expected bonus income'.
The rules for income tax and employer NICs will be aligned so that employer NICs will in future be payable on all payments above £30,000.
The foreign service exemption will be abolished.
A missed opportunity for genuine simplification
The current regime for termination payments is complex; the Office of Tax Simplification (OTS) identified various aspects of the rules which caused difficulties for employers and employees.
ICAS supported the introduction of a simpler overall regime. Unfortunately, this will not be the result of the current proposals unless they are amended.
ICAS suggests that it would be preferable to revisit the OTS suggestions for real simplification rather than replacing one complex regime with another.
Complexity and uncertainty
If implemented unchanged, the draft rules for identifying payments which would have been received if the employee had worked their notice period will add new complexity.
The rules are unlikely to be easily understood by employees or employers and will create new uncertainties and administrative burdens, as well as higher tax and NIC charges for some employees.
There may also be considerable scope for disputes about the calculation of the taxable amounts between employers, employees and HMRC.
Support for those who lose their job
One policy objective of the proposed changes is that “the tax system should continue to provide support to those who lose their job”.
The consultation notes that individuals will continue to be supported through the retention of the exemption from income tax for the first £30,000 of a termination payment. Also, the exemption from employee NICs on termination payments remains unchanged “to minimise the impact on individuals”.
However, these statements ignore the affect of the changes made to the scope of the exemption for termination payments. Increased employer NICs on payments over £30,00 are also likely to lead employers to reduce payments.
The changes will increase the tax/NIC yield for the Exchequer and this will inevitably mean smaller payments for employees. The likely impact of employers’ NICs on termination payments above £30,000 may not be regarded as a major issue by government as the average termination payment is around £14,000.
However, the post-employment payment rules affect a wider range of recipients.
Draft legislation: calculation of ‘post-employment notice income’ and ‘expected bonus income’
As outlined above these calculations are likely to cause difficulties for employers, employees and HMRC if the proposals are not amended.
The ICAS response to the consultation discusses various problems with the draft legislation in more detail.
Employers may want to watch out for an announcement on the outcome of the consultation in the Autumn Statement.