Kate Brooks
Partner, Solicitor & Head of Employment/HR Services
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Date Published:02 Oct 2018 Last Updated:23 Jun 2021

New Tax legislation and Settlement agreements – Can you still make a tax free payment under a settlement agreement?

Employment Law Advice

Previously you could offer an employee a discretionary termination payment of up to £30,000 tax free. In some situations a payment in lieu of notice used to be paid tax free in this amount.

As of 6th April 2018 this was no longer possible, and a payment in lieu of notice is taxable regardless of whether there is a contractual right to do so or not.

The new legislation also clarifies when National Insurance Contributions (NIC) are payable by the employer in respect of these types of compensation payments which are usually paid under a settlement agreement.

How does it affect the employer?

An employer is now liable to pay National Insurance Contributions on termination payments made to employees which exceed the current £30,000 threshold.

Specifically in relation to payments in lieu of notice (PILON) the new legislation clarifies that these payments are to be subject to both Income Tax and Class 1 NIC’s. This is regardless of how the employment contract has been drafted, in an effort to remove the loophole that allowed employers to manipulate the rules and minimise the value of taxes that would normally be due.

As an employer, you are required to identify the amount of basic pay that the employee would have received had they worked their notice period, regardless of when the employee actually leaves. That amount is treated as earnings and will no longer be included in the £30,000 tax exempt threshold.

Any NIC’s that an employer is required to pay will be collected in real-time as part of the standard weekly or monthly payroll returns to HMRC.

How does it affect the employee?

As an employee, if you do receive payment in lieu of notice, you should expect to have deductions made for both Income Tax and National Insurance at the current rate.

For all other payments received in association with the loss of a job, the existing £30,000 Income Tax exemption will still apply, alongside the NIC’s exemption which is unlimited.

Statutory redundancy remains exempt from both Income Tax and NIC’s.

If you are currently looking at redundancy within your business, or you have been placed at risk of redundancy, or you are looking to negotiate a settlement agreement, or have a settlement agreement explained and would like more specific advice on how the new legislation will affect you, then please give our Employment team a call on 01202 525333 or e-mail