The new financial year will bring with it several areas of increased cost for employers. We set out a number of key changes relating to termination payments which employers need to be aware of, below.
Payments In Lieu of Notice (a “PILON”)
Whether a PILON is subject to tax and NIC currently depends on the terms of an employee’s contract. If there is a contractual right to make a PILON, any such payment is usually treated as taxable earnings and subject to income tax and NIC. Contrastingly, non-contractual PILONs benefit from a £30,000 tax exemption derived from the current section 403(1) of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”).
From 6 April 2018 this position is changing. Through the insertion of new sections 402A – 402D to ITEPA employers will now be required to calculate the employee’s total basic pay including in respect of notice (whether or not served), and deduct from that sum income tax and both class 1 and 2 NIC. This means that both contractual and non-contractual PILONs will be subject to the usual tax and NIC deductions. HMRC have however confirmed that this change will not be retrospective.
Tax exemption for payments in respect of injured feelings?
Remaining unchanged despite the Government’s updates to the termination payments regime, is section 406B of ITEPA’s general exemption from tax for payments in respect of “injury to, or disability of, an employee”.
Nonetheless, through the insertion of new section 404B(7) to ITEPA payments by employers in respect of mere injury to feelings will not benefit from this tax exemption from 6 April 2018. Although employers will see this as another source of increased expense this change incorporates what has been the case law position since K Moorthy v HMRC  which ended this debate and held that a payment in respect of injured feelings was taxable.
Mounting auto-enrolment obligations
From 6 April 2018, the mandatory contributions to be made by both employee and employer in respect of the auto-enrolment scheme will begin to increase.
The minimum employee contribution will rise from 1% to 3% and the corresponding minimum employer contribution will rise to 2%. These figures will further increase to 5% and 3% respectively from 6 April 2019.
Much commentary has focused on the potential increased cost to employers of complying with their auto-enrolment obligations. We agree that employers are likely to see balance sheets dented more by pension liabilities than at present, but this impact may be softer than anticipated. This is owing to current inflationary pressures which we expect to lead to an increasing number of employees choosing to opt out.
Foreign Service Relief (“FSR”)
6 April 2018 also sees an end to the application of FSR in relation to termination payments made to employees who had worked overseas but received a termination payment during a tax year when they were resident in the UK. This is despite some trepidation displayed from influential lobbies, including but not limited to the Chartered Institute of Taxation.
As currently drafted, even where an employee (except if exempted) has served the majority of their employment abroad but receive a termination payment during a tax year when they are resident in the UK no FSR would apply and the total sum would be treated as taxable earnings and subject to tax and NIC. Here we see the potential for significant and unexpected liabilities to occur. As a result, it is possible that employers may be expected to increase or “gross up” termination payments to employees now tax resident in the UK but who have previously worked overseas.
Employers considering dismissals may wish to expedite these processes especially if they want to offer a tax free inducement as a settlement term.
Potential increased tax liabilities for employers may ultimately be minimal. Yet, given the financial and reputational cost of a dispute with HMRC for contravention of these provisions would probably be significantly more costly, employers should actively take steps to prepare for implementation. This should include making sure that the internal payroll and HR functions are fully abreast and trained in respect of these changes.
The proposed changes to FSR in 2019 are an area we will be proactively monitoring. If the Government does not amend the draft legislation as it relates to FSR, employers, particularly those with an international base will need to plan their human resources and dismissal considerations more carefully to avoid unexpected liabilities falling due.
 Termination payments: removal of Foreign Service Relief (FSR) for UK Residents Response by the Chartered Institute of Taxation, 25 October 2017
Our employment department has experience and expertise in all of the above areas.
If you would like any further information, please contact Noel Deans at firstname.lastname@example.org or on 0207 955 1413.
This article should not be taken as definitive legal advice on any of the subject matter covered. If you do require legal advice, please contact Rosenblatt as above.