Proposed reforms to PILONs

The Government has recently published its proposed reforms to PILONs, set to take effect in 2018. How will these affect you?

PILON, or payment in lieu of notice, refers to the payments that can be made to an employee upon the termination of their employment. I used to work with someone who said that you could not call yourself an employment lawyer until you understood PILON clauses.

An employee who is told that they no longer have a job would either be asked to work their notice, put on garden leave, or could be paid instead for the value of that notice period but leave straightaway.  In the latter situation, if there is a clause in the employment contract allowing the employer to do this then the PILON payment must be taxed in the usual way.  However, without this clause the employer can say they have breached the employee’s contract and can pay the notice pay free of tax and National Insurance.  This can often be a very significant saving and also attractive to high earners as it is a way of effectively giving them an enhanced severance payment.  In all cases the tax relief only applies up to £30,000.

All Change

This will all change in 2018.  The government started a consultation on the taxation of termination payments back in 2015 and has recently published its proposals.  Three main reforms are proposed:

1. payments in lieu of notice will be chargeable to both Income Tax and National Insurance contributions regardless of whether there is a PILON clause in the contract of employment or not
2. Currently termination payments up to £30,000 can be paid free of Income Tax and National Insurance contributions. A termination payment in excess of £30,000 is taxable on the balance above £30,000 but is not chargeable to National Insurance contributions.  Under the new proposals, the excess above £30,000 will be chargeable to employer National Insurance but not employee National Insurance contributions
3. The tax exemption on compensation payments for injury to feelings will be removed except where the injury amounts to a psychiatric or other recognised medical condition. That will probably require the taxpayer to obtain a medical report to persuade HMRC that the exemption should apply

Termination payments will become more expensive

This is a draft proposal and the government invited comments by 5 October 2016 in order to be published in the draft Finance Bill in 2017.  Employees will still have access to the £30,000 tax exemption where their employment is being terminated but if this proposal becomes law it will not be possible for employers to be “creative” with notice periods and PILONs.

It will certainly make understanding PILON payments much simpler and will prevent tax avoidance.  However it could also make terminating employees more expensive.