Spring has sprung in the United Kingdom – a good time for a reminder of the annual statutory rate changes for employers, along with other changes to the taxation of termination payments. The following summary of these changes aims to arm employers with information they should know.

New Statutory Rates and Limits

Employers and HR representatives in the U.K. should be aware of key statutory rates and limits, as detailed in the table below.

Changes to Taxation of Termination Payments

Changes to Payments in Lieu of Notice

In the United Kingdom, when an employer decides that an employee is not required to work through his or her notice on termination of employment, and the employer makes a payment in lieu of notice (PILON) in line with the contractual provisions of the employment contract, this payment is subject to Income tax and class 1 National Insurance Contributions ("NICs”) through automatic deductions made under the PAYE (Pay As You Earn) system as part of normal payroll.

Where there is no contractual provision giving employers the right to pay employees in lieu of their notice period, such payments are often paid as damages for breach of contract. Historically, this compensation could therefore be paid without deductions for tax (up to the first £30,000) or NICs.

As of April 6, 2018, however, all non-contractual payments made in lieu of notice will be subject to income tax and NICs, in the same way as contractual PILONs are currently taxed. These changes could impact the total costs of severance packages, so employers should bear this new treatment in mind when entering into termination discussions and packages.

Effective Date

As noted, beginning April 6, 2018, payments made in respect of notice pay must be subject to tax and NICs—regardless of whether a PILON clause exists. In its February Employer Bulletin, HMRC (Her Majesty’s Revenue & Customs) stated that the new rules will apply only to payments made after April 5, where the employment also terminates after April 5. Under that interpretation, the new rules supposedly would not attach to terminations taking effect before April 6. However, HMRC’s guidance on this point is arguably at odds with the wording of the legislation. Employers making termination payments on or after April 6, 2018 with respect to terminations occurring before that date might consider seeking an indemnity from the employee.

Calculation of Payments

As a practical matter, the amended rules require an employer making a relevant termination award to calculate how much of the award is “post-employment notice pay” (PEN Pay). PEN Pay will be subject to income tax and NICs, while the balance of the payment will be eligible for the usual £30,000 tax and NIC exemption (but subject to tax and NICs over that amount).

How is PEN Pay calculated?

Employers should carry out some calculations to work out how to tax these payments, as per the below. It is a bit technical; but the example below generally explains how it should work in practice. 

BP x D

__________ - T

P

Facts: Roger’s employment is being terminated. Roger will be paid in lieu of his 60 days’ notice. Roger’s basic salary is £5,000 (paid monthly). His employment contract does not contain a PILON clause. Roger is agreeing to new restrictive covenants, and will receive £500 for this concession. Roger is receiving £10,000 as an ex gratia-payment (that is, a voluntary payment from his employer), in addition to his notice pay and restrictive covenant payment, leading to a total relevant termination award of £20,500.   

Applying the PEN Pay Formula

What does this calculation mean?

Roger’s PEN Pay is £9,500, which must be subject to income tax and NICs in its entirety. The £500 payment made in respect of restrictive covenants must be subject to tax and NICs as normal. The remaining £10,500 of the relevant termination award can be paid on a tax-free basis under the £30,000 exemption and without deduction for NICs.

Foreign Service Relief

U.K. resident employees who spend a substantial part of their overall service working overseas have long been able to benefit from a complete tax exemption. As of April 6, 2018, however, Foreign Service Relief will effectively be abolished for employees who are U.K. residents for the year in which their employment terminates, regardless of their overseas service.

Injury to Feelings

Finally, effective April 6, 2018, discrimination-related compensation for injury to feelings (which is similar to emotional distress damages in the United States) paid on termination will no longer be tax-exempt unless the injury relates to a psychiatric injury or other recognised medical condition.  

Summary

Employers in the U.K. should stay abreast of the annual statutory rate changes, along with other evolving labor and employment issues. In particular, the amended taxation rules are fairly complex, with several new acronyms and nuances to get your head around. HMRC has promised to issue guidance “soon”, so we will continue to monitor developments on this topic and will provide another update when HMRC has issued its guidance.