Whenever an employee finds their employment terminated, whether by reason of redundancy or under a compromise agreement there are taxation issues which arise. The Question is what is taxable? This brief article will focus only on the right to Notice and/or a ‘Payment in lieu of notice’ (“PILON”)
Under the Income Tax (Pensions and Earnings) Act (‘the Act) all normal income is subject to payment of income tax and national insurance provided an individual will earn over a minimum level as prescribed by the government from time to time. Tax codes are provided to assist employers with managing the liabilities via their regular PAYE payroll throughout the year.
However, parliament has foreseen certain circumstances whereby income tax and national insurance should not be deductible from payments made, for example. in respect of say a statutory redundancy payment, and therefore under limited circumstances some payments may be exempt. The relevant exemptions for the purpose of this article are contained between s.401 and 406 of the Act which allow some payments to be tax free.
Essentially, in a nut shell, the exemptions provide that any sum of damages or payment which does not stem directly from the contract of employment, and up to the value of £30,000, may be paid tax free.
This has given rise to people seeking to utilise the provisions for their own benefit when considering the termination of employment with a view to avoiding payment of income tax and national insurance by receiving a PILON and claiming that it falls within the £30,000 exemption. Is this correct?
As a general rule no; it is highly unlikely that treating a PILON as falling within the exemptions will work, because:
a) If notice is properly given but an employer simply informs an employee that they need not attend work during his or her notice, and the employment expires at the end of the notice then the employee is simply receiving their wages in the normal way and therefore such payments are subject to deductions. It is irrelevant whether the wages are paid periodically or as a lump sum.
b) Most contracts will contain a payment in lieu of notice clause which gives employers the right to make PILON rather than making them work their notice period, or having a termination date in the distant future at the end of the notice period. If that clause exists then making a PILON will not amount to a breach of contract, and the sum will come directly from the employee’s contract of employment, as such it is taxable.
c) Even if an employee’s contract is silent and the parties reach an agreement as to the payment of wages for the notice period, it is still not clear cut. On face value it would appear that income tax and national insurance is not payable upon such sums as it is not a normal payment arising from the contract, but rather damages. However, the HMRC will look at the course of conduct previously adopted by the employer. If it has previously and frequently made PILONS then as an anti-avoidance measure the HMRC may seek to treat the payments as taxable and a PILON clause as referred to in (b) may deem to be implied into the contract.
It therefore follows that when making a PILON to an employee, neither party should simply take the view that it can be paid without deductions. It may only be paid without such in the event that it is a genuine payment of damages in breach of contract and not made in respect of any work carried out by the employee and/or under any contractual term.
If you are considering making a PILON we would always advise that you seek advice from an Accountants so that you can accurately plan for any tax liabilities, and legal advice so that we can advise you on the safest manner in which to make such payments.