Tax on termination payments - how are settlement agreements going to be affected?
Tax change to Notice Pay comes into force
From today, 6 April 2018, it will not normally be possible to make tax free payments in lieu of notice (often referred to as damages) to employees leaving employment.
Employers will instead have to tax notice payments made to employees in line with new tax laws.
Under the new rules when an employee’s employment terminates, an amount equivalent to the employee’s basic pay for their notice period will need to be accounted for as taxable employment income.
This is called post-employment notice pay or PENP.
Complex provisions apply to determine how this is calculated in each case.
For a more detailed look at the provisions and how they will apply when exiting an employee under a settlement agreement, please see our article on tax on termination payments.
There are a number of other considerations which employers should bear in mind before these changes come into force:
- The new rules are likely to be a problem if you do not know what an employee’s notice period is.
- Now is a good time to therefore ensure that your arrangements are clear and that you have up to date contracts of employment in place.
- Employers who have previously not had a payment in lieu of notice clause in their employment contracts may wish to revisit this in light of the changes. The previous potential tax advantages, in not having a payment in lieu power, will no longer apply or apply to the same extent.
- Advice should be sought when employees are being given a settlement agreement and employers should bear in mind the additional costs which are now likely to be faced when terminating an employee’s employment under a settlement agreement.
- If you have paid notice pay tax free until now the cost impact could be significant. If you have paid notice pay as fully taxable the cost impact will be limited.