As regular readers of our newsletters will be aware, the tax and NIC treatment of termination payments is a complex and constantly moving area of taxation.
To understand about the PAYE & NIC treatment of ‘ex-gratia’ compensation payments, restrictive covenants (especially when combined with the use of compromise agreements), payments on retirement and continuing benefits post termination please have a look at earlier newsletters.
An employee’s contract can be terminated for a number of reasons, and by a variety of methods – redundancy, resignation, dismissal, retirement and even death.
The employer is responsible for ensuring the correct PAYE & NIC treatment is applied to any Payment In Lieu of Notice (PILON), and the employer will be held liable for any under-deduction with statutory interest and penalty addition.
The Special Commissioner’s decision, and subsequent High Court decision, in SCA Packaging v HMRC does now help shed some light on the correct treatments, at least until HMRC take the next PILON case to a hearing.
Basically, PILONs can be broken down into four categories:
1. Contractual
If an employee’s contract contains a PILON clause, i.e. you/ we can terminate your contract on payment of your notice period, and the employer then terminates the contract and pays the PILON the payment is deemed to be ‘earnings’ and should be subject to PAYE & employers/ employees NIC in full.
Care should also be taken where an employee’s contract contains a PILON clause and this is subsequently removed, especially with a proposed termination in mind. HMRC are likely to challenge the commerciality behind the decision.
2. Discretionary
If an employee’s contract contains a discretionary PILON clause (eg “we reserve the right to make a payment in lieu of any contractual notice period in the event of the termination of this contract”) and the employer exercises the discretionary right, the payment is also deemed to be ‘from the employment’ and should be subject to PAYE & NIC in full.
Again, care should be taken where part of the notice period is worked and the remaining notice is paid – as HMRC will deem this to simply vary the PILON and the payments remain liable to PAYE & NIC in full.
3. Customary/ Auto-PILON
Probably the most contentious area of PILON payments currently is ‘auto-PILONs’. These are situations where the employee’s contract contains neither a PILON clause nor discretionary PILON clause, and the employee receives a gross PILON on termination.
Since Tax Bulletin 63 (February 2003) the Revenue has advised that any PILON payments made as an automatic response to a termination are ‘earnings’ and as such are subject to PAYE & NICs in full. These have also been described as ‘custom and practice’ payments, and HMRC are still looking to challenge these sorts of payments.
The solution is quite simple. Where there is a genuine critical assessment in making the payment, HMRC may accept that ‘auto-PILONs’ do not exist. Alternatively, if only the net payment of damages is made (i.e. the equivalent of the net salary) or substantial negotiations have been involved, then it is unlikely that taxable ‘auto-PILONs’ exist.
This is an area where HMRC look to challenge, not only during Audits, but also as ad-hoq pieces of work. If any redundancy programmes are planned, it is possible to obtain advance clearance of the tax & NIC treatment.
4. Compensatatory
Finally, if there are not contractual PILONs, discretionary PILON or ‘auto-PILONs’ it is likely that any payment for unworked notice is likely to be compensatory in nature and falls under the £30,000 exemption.
adtax can work with finance, tax and HR teams if any termination payments are being considered – whether they are individual terminations or a larger scale redundancy programme. By negotiating with HMRC on your behalf, we can mitigate any exposure, and obtain preferential treatment for both employer and employee – invariably saving the employer significant sums of money.
PILONs and termination payments are also relevant for employment law reasons. Simon Rhodes, Partner at Trethowans, is able to provide businesses with practical, straight forward advice regarding employment law considerations.
This page was last updated on Friday, January 04, 2008.
