Tax update and PENP rules

Siobhan Bishop: Hello and welcome to this podcast where we are discussing the tax rules for payments in lieu of notice and other employment related tax developments. I am Siobhan Bishop a Principal Associate in the Employment, Labour and Equalities Team at Gowling WLG and I am joined by Zoe Fatchen, a Partner who leads the team advising on employment related tax matters. So Zoe, there was a significant change to the tax treatment of payments in lieu of notice which was introduced on 6 April 2018; what is the effect of this change?

Zoe Fatchen: Well Siobhan, first of all I think to understand what the effect of the change is we need to have a quick look at what the position was before. So historically, payments in lieu of notice which were enshrined in contract were subject to tax anyway, discretionary payments in lieu of notice, so where the employer could choose to make a payment in lieu of notice (PILON) payment were also subject to tax, but there was a grey area around discretionary payments in lieu of notice which were not in the contract and the rules previously said that if the employer had a custom or practice of making PILON payments, and particularly if the employee had an expectation that they were going to receive a PILON payment, then that would also be subject to tax. But then we got into all sorts of questions about what does that really mean if there is a custom and practice and how can that be proved evidentially? And so, in order to clarify the rules, it has now been determined that all payments in lieu of notice will be subject to tax, and that then of course brings up the question about what do we include as a payment in lieu of notice? Can we make a small payment in lieu of notice and then make another payment which is described as something else in order to give the employee the economic equivalent of a payment in lieu of notice but while escaping these new rules? And the answer to that is emphatically no. The reason for these changes are to make sure that that is not the case, so what we have now is the concept of post-employment notice pay and what that means is where there is a foreshortened amount of notice given compared to what the employee was contractually entitled to receive, there will be a deemed amount of any settlement payment which is treated as a payment in lieu of notice and taxed accordingly. So what that means is if the employee works for the whole of their notice period then they will be taxed on their earnings during that period in the usual way. If they go on garden leave for all or some of their notice period, then that also will be subject to tax in the same way as salary, so income tax and national insurance contributions. If part of the notice is worked or part of the notice is garden leave, or perhaps both, then that element again will be subject to tax in the normal way and then for the period when the notice was foreshortened and payment in lieu is given, then that is where we start to look at an apportionment of that period of time and then we start to look at this post-employment notice pay, this PENP calculation.

Siobhan: OK so a lot of employees will probably still be expecting or have heard of this so called £30,000 tax exempt amount which they are entitled to in relation to any settlement on termination. Where are we up to with that?

Zoe: OK, well the position in relation to the £30,000 exemption has always been that it applies to sums which are not taxable in any other way under the legislation. So things that have always fallen outside the £30k exemption still do, so that would include, for example, contractual entitlements that the individual might have such as accrued holiday pay benefits under their contract which they are entitled to receive. So the £30,000 exemption is still in the legislation it is just that now we have another item which falls outside it. So to the extent that someone has received a deemed amount of post-employment notice pay under the calculation which is greater than the payment in lieu of notice that they actually receive, that could mean that where the £30,000 exemption is not used in full against other things and would otherwise have been used against a compensation payment, some of that compensation payment may be taxable as part of this deemed post-employment notice pay. So the £30,000 exemption still exists it is just that where payment in lieu of notice is not given in full as worked out according to the calculations in the new rules, then some of that £30,000 may not be available to that particular employee and that is where we get into the complications around calculating what they are actually receiving, what they are deemed to receive under the legislation and how that may or may not impact the £30,000 exemption and that will vary from case to case depending on the employee's particular circumstances.

Siobhan: OK thank you very much, and what other changes have there been recently?

Zoe: Well, in addition to the post-employment notice pay changes there have been some other changes which are intended to simplify the rules and/or to bring them up to date a little. So, with effect from April 2019 the rule in relation to amounts in excess of that £30,000 exemption changes. Up until now, if an employee receives compensation or sums which would otherwise not be taxable which exceed the £30,000 amount, then all they would pay on the excess would be income tax. From April next year, amounts in excess of that £30,000 will also be subject to employer's national insurance contributions, so that's a liability on the employer not on the employee. So as far as the employee is concerned, they will still only see income tax deducted from the sum which is paid to them under their settlement agreement, but from the employer's perspective when working out the budgeting and the costings of the termination of employment, they will also need to factor in the additional employer's national insurance contributions that apply and of course it is not possible to pass on that cost to the employee as a matter of law.

There is one other change here that I think is worth noting now and that is a change in relation to foreign service relief, specifically with respect to termination awards. So from April this year, foreign service is no longer taken into account when working out how much of the termination award is going to be taxable. So if the employee is a UK tax resident, when their employment terminates, the whole of that termination payment will be subject to UK tax under the usual rules as if they had always been resident in the UK, and that is the case even if they were resident outside the UK for some or even most of the time when they were engaged in that particular employment. So you can see that if someone is working outside the UK and they are thinking about moving back to the UK and it is likely that the employment is going to terminate then or very soon after, if the termination is already in view then it may be better for both parties to terminate that employment before they come back to the UK for tax purposes.

Siobhan: OK thank you very much Zoe for all that detailed and quite complicated information, but what should employers be doing practically? What do they need to be aware of and how can we help?

Zoe: OK well the first thing to be aware of is that these new calculations exist and when someone is receiving a payment in lieu of notice for a period and that doesn't reflect the full entitlement they would have had to salary and perhaps to certain benefits during that period, it is very important that someone carries out that post-employment notice pay calculation. Now often that will be whoever deals with the employer's payroll, so that might be someone internally or it might be an external provider. We are finding that some external providers are quite reluctant to carry out these calculations because they are concerned about whether they have all the relevant facts to hand. It is likely that over time that that wariness will abate as they become more accustomed to these rules and accustomed to dealing with them. There are some tricky points of law around what should or shouldn't be included at various points in the formula. That's detail which is really beyond the scope of the podcast today but that is certainly something that we can help with. So what we have seen so far from employers are lots of questions around how to calculate PENP, questions about when it's relevant, questions about how to communicate those issues to employees and we can certainly help with that and also the importance of getting together a comprehensive set of guidelines to be used internally either by payroll or by the internal HR Team, or whoever is responsible for carrying out those calculations, so that it's as clear as it can possibly be for both the employer and the employee what tax should be levied and how much the employee is going to be left with net of tax in their hands once the termination is all done and dusted.

Siobhan: So thank you very much Zoe for that interesting update and for all those tricky issues there that you've raised, and if you would like to discuss any of these issues in more detail, please do feel free to contact Zoe.