Beware. From 6 April 2018 all pay corresponding to notice will be subject to deductions for income tax and employer and employee National Insurance Contributions (NICs). The current position is that if there is no payment in lieu of notice clause (PILON) in the employment contract and the employer pays out and asks the employee to leave, income tax and NICs may not have to be deductible. That, however, will no longer be the case.
The new law will have important implications in terms of the £30,000 tax exemption which applies to some termination payments.
The law as it stands
If there is a clause in the employee’s contract allowing the employer to pay them off in lieu of them serving their notice (PILON), which the employer exercises, tax and employer and employee NICs are due on the notice monies. The £30,000 tax exemption would not apply.
But if there is no PILON in the contract the monies equivalent to the notice period would, generally, not be subject to tax and employer and employee NICs. Any sum in excess of £30,000 would be subject to tax, though no employer or employee NICs would be due.
An employer could structure an exit arrangement so that a sum which might otherwise have been paid as notice monies could be paid without any employer and employee NIC deductions and be tax-free up to £30,000.
From 6 April 2018 it will be irrelevant whether an employee has a PILON in their contract. All sums corresponding to earnings for notice will be subject to tax and employer and employee NICs.
From 6 April 2019 it is also expected that employer NICs will be due on the balance of any non-contractual termination payments over £30,000.
Use of PILONs
Some employers have deliberately not included a PILONs in contracts so that there is more flexibility in structuring an exit deal. However, if no PILON is included and the employer pays the employee in lieu of notice, the employer would be at risk of breaching the contract. An employee could then argue that any restrictive covenants in the contract are no longer enforceable because of the breach.
Since employers will no longer benefit from a PILON-free contract, PILONs should be included in contracts. This will avoid risk of a breach for paying in lieu of notice and not being able to enforce restrictive covenants.