The draft UK Finance Bill 2017 (the “Bill”) proposes some significant changes to the tax treatment of a payment in lieu of notice (“PILON”) for employees.  Where a UK employer exercises a contractual right to make a PILON, the payment is fully taxable and subject to national insurance contributions (“NICs”) as income, in the same way as salary.  However, where there is no contractual right to make a PILON, and the employer chooses to terminate the employee’s contract in lieu of notice, any payment made to the employee to cover the amount that they would have received if they had worked their notice in full constitutes damages for breach of contract. Such payment could therefore be paid free of tax up to £30,000, and free of both employer and employee NICs.

The Bill proposes that, from April 6, 2018, all PILONs (contractual and non-contractual) will be taxed as income, and will therefore be subject to income tax and both employer and employee NICs. This would apply only to the basic pay that the employee would have earned during this period.

In addition, any amounts in excess of the £30,000 tax exemption are currently subject to income tax, but not to any NICs. The UK government has proposed to subject such excess to employer (but not employee) NICs. If passed, this provision would take effect from April 2019.

Although the Bill is only in draft form currently (and its scope subject to change between now and April 2018), UK employers should carefully consider any proposed terminations that may be made after April 6, 2018, in order to minimise any potential tax liabilities that could arise for both the employer and the employee.