October 23, 2016

What is changing with Termination Payments?

what is changing with termination payments?

The Government has been looking at the tax and National Insurance treatment of termination payments. They consulted last summer on possible changes and have recently published their response to the consultation, together with draft legislation. Some of the proposals are to be implemented. Others have fallen by the wayside. So what is changing and when?

Current rules

A termination package typically includes a number of elements, for example, salary, holiday pay, compensation for loss of office, pay in lieu of notice, and statutory redundancy pay. Different tax and National Insurance treatments apply to different elements of the package. So, to tax the package as a whole, it is necessary to identify each component part and tax that correctly.

Some payments made on termination are payments of earnings and attract PAYE tax and National Insurance. This is the case, for example, for payments of outstanding salary and for holiday pay. Other elements of the package are compensation payments designed to compensate the employee for losing his or her job. Redundancy pay and compensation for loss of office fall into this category. Payments which are taxed as termination payments rather than earnings benefit from a £30,000 tax exemption and are also currently free of National Insurance, even to the extent that they exceed the £30,000 tax-free limit.

Payments in lieu of notice (PILONs) are tricky. Broadly, a PILON which is contractual or expected is treated as a payment of earnings and is subject to PAYE and NIC without the benefit of the £30,000 exemption. By contrast, a non-contractual PILON is taxed as a termination payment and benefits from the £30,000 exemption.

From April 2018

Although the basic approach will still be to identify the component parts and apply the correct treatment to each part, some changes to the rules are being introduced from April 2018.

From that date, termination payments in excess of the £30,000 exemption limit will attract employer’s National Insurance contributions. However, as now, no employee National Insurance contributions will be payable.

More fundamentally, all PILONs will be treated as earnings and taxed as such. This means PILONs will no longer benefit from the £30,000 exemption even where the payment is non-contractual and damages in nature. Consequently, all PILONs will be liable to PAYE tax and National Insurance (employer’s and employee’s).


Plan ahead – pay non-contractual PILONs before 6 April 2018 where possible to take advantage of the £30,000 exemption where available.

No change to exemption

Despite consultation proposals to drastically change it, the £30,000 exemption will remain at its current level and in its current form. Proposals to replace it with a new-style (and lower) exemption, possibly linked to length of service, were rejected.

Please get in touch with us at Inform if you need further advice on what is changing with termination payments or for any other tax related matters.  


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