Unemployment is clearly going to be one story that is rarely out of the headlines during the coming months, particularly as the statistics are sure to be swelled by previously furloughed employees once the government’s Coronavirus Job Retention Scheme ceases at the end of this October.
Some forecasters are talking about the UK unemployment rate (currently 4.1%) nudging 15% if we experience a second wave of the epidemic and, even if we are spared one, predictions of rates of over 10% by the end of this year are not uncommon. ¹
So, any companies likely to have to lay off staff should make sure they are up to speed with rule changes affecting a particular type of employment termination payment known as ‘Payment in lieu of notice’ (PILON).
We know that this is a blind spot for many employers, and we have had several queries raised by clients who have been asked by their employees to place such payments in their pension schemes.
PILON payments are made to employees when their employment is terminated without notice, as opposed to them working through a notice period and receiving their salary in the normal way. They should not be confused with ‘gardening leave’ – where, although the employee isn’t present at work, they are still in employment and being paid during the notice period.
Up until a couple of years ago the taxation of PILON payments depended largely on whether they were allowed in the contract of employment.
If the employee had a contractual right to a PILON payment then it was taxed in the same way as other contractual benefits given to the employee.
If, on the other hand, the employee had no such contractual right and their employer terminated their contract without proper notice, making a payment in lieu of the notice period, then that payment was generally tax-free up to £30,000.
But all this changed with the introduction in April 2018 of new rules under the Finance (No 2) Act 2017 affecting termination payments. These effectively brought the tax treatment of PILON and non-PILON payments into line with each other.
Since then if an employer pays a ‘relevant termination award’ to an employee it has to calculate how much of that award is ‘post-employment notice pay’ (PENP) – broadly the basic salary the employee would have received during any unworked period of notice minus any contractual PILON payment. ²
The changes were intended to bring fairness and clarity to the taxation of termination payments, ensuring that tax consequences are no longer dependent on how the employment contract is drafted or whether payments are structured in some other form, such as damages.
But they have also brought significantly increased administrative hassle for employers, who are now obliged to calculate exactly how much basic pay employees would have received if working out their notice period and divide a termination payment between the proportion treated as earnings and the proportion being paid in compensation for loss of employment.
A further consequence of the changes is that making a non-contractual PILON payment can result in a greater cost to the employer – and potentially also to the employee.
Employers will have to pay the employer National Insurance Contributions (NICs) on the PENP, and the employee will have to pay Income Tax and employee NICs on the PENP. ²
It should also be noted that the changes might not make salary exchange an appropriate option when PILON payments are involved.
Salary exchange arrangements (even if they were implemented well before there was any thought of terminating an individual’s employment) are ignored when calculating PENP.
So, if salary exchange is being used, paying a PILON is likely to cost more – regardless of whether a PILON clause is included within the employee’s contract of employment. The employer will have to pay employer NICs on the salary sacrificed, and the employee will have to pay Income Tax and employee NICs on that salary.²
Content correct at the time of writing and is intended for general information only and should not be construed as advice.