Barry Stanton, partner in Boyes Turner's employment team, discusses the recent changes to taxation of Termination and Injury to feelings awards following changes to law in April 2018.
Taxation of Termination payments
Possibly not the most exciting subject, but one that has taken on greater importance since 6 April 2018 because the rules have changed. The aim of the change is to ensure that all payments of notice pay are subjected deductions for tax and National Insurance Contributions.
Historically some employers have avoided using Payment In Lieu of Notice (“PILON”) clauses in employment contracts with the aim of being able to make a tax free payment of notice pay on termination. For dismissals occurring on or after 6 April 2018, that is no longer possible as the PILON will be subject to deductions for tax and employee NICs. However, the £30,000 will be available on the next portion of any termination payment.
The new rules introduce new terminology and refer to a Termination Award which is the payment made to the employee less any statutory redundancy pay and any “approved contractual pay” where it does not exceed the statutory redundancy pay.
If employees work for their entire notice period and are paid an additional sum these new rules should not have an impact.
Where some or all of the notice period is not worked then an employer needs to calculate the employee’s Post Employment Notice Pay (“PENP”). PENP is calculated for monthly paid employees as:
Basic pay x length of notice period - amount of termination award from which tax already deducted.
If employees are not paid monthly the calculation is:
((Basic pay x notice period in days)/no. days in pay period) - amount of Termination Award from which tax already deducted.
The PENP must then be compared to the Termination Award. If PENP is less than the Termination Award, the PENP is subject to deductions for tax and NICs. The next £30,000 can be paid without deductions; any excess is subject to deductions for tax.
Where PENP is greater than the Termination Award, the entire award has deductions for tax and NICs.
Joe earns basic pay of £4,000 a month. He has a three month notice period. He is paid in lieu of notice and given a Termination Award of £20,000.
PENP = 4000 x 3 - 0 = 12,000
Tax and NICs are deducted from £12,000 and £8,000 is paid without deductions
The new rules make the taxation of termination payments more straightforward because all PILONs are taxable but the mechanism for calculating tax is complicated. It also means that for those who regularly use settlement agreements that those agreements need to be revised to take into account the new rules.
Although the legislation says that it applies to all payments made after 6 April 2018, HMRC have indicated that it will only apply the rules to payments agreed and made after 6 April 2018.
This note summarises the new rules however, there is greater complexity to them. If you have any questions about this tax change to termination payments please speak to a member of the Employment Group.
Taxation of Injury to feelings awards – all change!
Certain Tribunal claims permit a successful party to claim “injury to feelings” in addition to any financial loss. In recent years there has been an ongoing debate about whether such sums were capable of being paid tax free. Injury to feelings awards were subject to the limits set out in Vento and other cases, currently with a maximum value of around £40,000.
Mr Moorthy settled his unfair dismissal and age discrimination claim by accepting an ex gratia payment of £200,000. £30,000 was paid by Jacobs without deductions of tax. He attempted to argue that the entire award should be exempt from tax. HMRC offered to allow him to have an additional £30,000 tax free on the basis that it was an award for “injury to feelings”.
The Tax Tribunals held that injury to feelings awards, in this context, were not capable of being paid tax free, despite HMRC’s concession. However, the Court of Appeal held, last week, that injury to feelings awards “in respect of actionable discrimination on grounds of age, as falling within the exemption is s406”.
What is true for age must also be true for other forms of discrimination, and also whistleblowing.
The Court expressed no view on the position of payments for injury to feelings where there was no statutory basis for such a claim. However, such payments must be at serious risk of being taxed.
This is good news for employers and employees, seeking to negotiate a settlement when they are trying to utilise tax exemptions.
However, the Court of Appeal pointed out that having decided in Mr Moorthy’s favour the Finance (No 2) Act 2017 had changed the position so that “Although “injury” in subsection (1) includes psychiatric injury, it does not include injured feelings.”
What the Court of Appeal have given with one hand, HMRC have taken back with the other. The Finance Act changes the position so that now only psychiatric injury will suffice. That is inevitably going to require an employee to have evidence of that injury. When faced with a discrimination claim in future an employer, absent cogent and irrefutable medical evidence should expect to tax an injury to feelings award.
Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.