Termination payments “simplifications” will just PILON more complexity

Tue 17 Oct 2017

[bctt tweet=”#PILONs complification- adding “tax simplification” is like trying to dig a hole smaller” username=”@chriswords1″]

After over four years of deliberation by the Office for Tax Simplification (OTS) and Government consultation we have the draft legislation that purports to simplify the taxation of termination payments by:
• adding eight new pages of dense, impenetrable legislation;
• partially removing an existing exemption; and
• imposing a new, additional class 1A NIC charge on employers.
The new legislation also addresses perceived abuse of the £30,000 exemption for redundancy and non-contractual compensation payments for loss of employment or office.

The “abuse” of getting contracts right

Some employers use contracts that include PILON terms, binding them to pay PILONs to all departing employees except “bad leavers”.
Others use contracts that make no such provision, also risking higher claims for compensation through employment appeal tribunals. But being aware that this may benefit some leavers who receive ex-gratia payments and gifts doesn’t make those employers tax abusers. These so-called abuses do not fall within the scope of any existing anti-avoidance legislation and certainly fall far short of the sort of practice covered by the GAAR, since they are widely accepted and regarded as reasonable and normal business practice.

Is increased complexity really the answer to poor understanding?

The underlying cause of the drive to change the rules is the perception that the present rules are poorly understood, open to abuse by those who do understand them and not applied fairly by employers who don’t understand them.  the Government believes this leads to both under and over-deduction of PAYE due to the lack of awareness of the differences in treatment between:

• contractual payments, in particular payments in lieu of notice (PILONs), which are taxable and NIC-able in full; and
• non-contractual payments, mainly where the employee’s contract does not include the right for the employer to terminate the employment without a breach of contract because the contract provides terms for payments in lieu of notice, where a £30,000 exemption from income tax is available and no NIC liability arises at all.

Payments in lieu of notice (PILONs)

The new provisions attempt to resolve the confusion by ensuring that all PILONs will be fully taxable to the extent that they represent basic pay, so additional payments compensating for lost bonuses or other potential entitlements may still be exempt, either in the £30k limit (bonuses, ex-gratia payments and lost entitlements) or absolutely exempt.
This is where the greatest complexity comes in because there are anti-avoidance rules to stop employers trying to get around the new rules by artificially depressing basic pay to make more of an award fall into the new exemption.

Other compensation

Compensation for lost earnings opportunities in the form of bonuses will fall within the £30k exemption and here there will still be scope for arguments about whether the compensation is for:
• non-payment of earnings to which the employee was already entitled, such as accrued bonus or performance-related pay entitlements that the employee is entitled to demand under the terms of the contract; or
• loss of the possibility of receiving such bonuses etc. because the termination of the employment denies the employee the opportunity to participate in the scheme, e.g. because termination fell before the cut-off date for the scheme.
In the latter cases it will still be necessary to examine the employment contract to distinguish between lost entitlements and lost opportunities.
The changes
The second Finance Bill of 2017, currently before Parliament, will amend Chapter 3, Part 6 of ITEPA 2003.
The employee termination payment rules are intended to work in two stages:
o first identifying all payments made on or after termination of employment, all of which are taxable and subject to NIC;
o then carving out those that enjoy the £30,000 threshold.
Foreign service relief is removed, except for seafarers (Income Tax (Earnings and Pensions) Act 2003 ss 413 and 414).
Class 1A NICs charge on termination payments over £30,000 where the earner also pays Income Tax on that termination payment (s 10 Social Security Contributions and Benefits Act 1992).
Redundancy payments
There will be a specific exemption for statutory redundancy payments but this will be restricted to statutory entitlement only. The scale of statutory redundancy payments is such that they cannot, on present rates, exceed the £30k exemption on their own. Statutory redundancy payments will still be required to be aggregated with other “exempt” payments for the purposes of the £30k exemption.
Collection- details to follow
This legislation does not set out the way that the Class 1A charge will be collected: secondary legislation is expected to apply the Class 1A charge in ‘real-time’, rather than after the end of the tax year, as with other Class 1A charges.

Payments that are still exempt

There is no change to the exemptions for payments:
• because of the death, disability or injury of the employee;
• under a tax exempt pensions scheme;
• to a registered pension scheme;
• for liabilities and indemnity insurance;
• to HM Armed Forces;
• by a foreign government; or
• in respect of certain legal costs.

simply more tax deductible

Broadly speaking the tax take will be increased by the additional class 1A NICs and income tax. How much additional revenue will be generated is not clear because the estimates provided to the Government by HMRC are admitted to be more “best guess” than scientifically based but the Government expects to bring in £400k per year more as a result.