PILONs: Taxing times

Felicity Gemson

When planning to make termination payments to departing employees, you’ll need to build in extra steps, and potentially extra budget, to comply with new tax changes. Get yourself a strong cuppa – and a calculator – in readiness for this whistle-stop tour of the key points.

PILONs may cost more

Under the new rules, all payments in lieu of notice (“PILONs”) are fully taxable and NIC-able, whether contractual or not. This is already the case for contractual PILONs (where there is a contractual PILON clause) and as I’ll explain shortly, there will usually be no more tax to pay on those, but a calculation will be needed to check that.

Non-contractual PILONs, on the other hand, are affected, as they are no longer tax-efficient. Until 5 April, these payments were exempt from NICs and up to £30,000 could be paid tax-free. With this tax break removed, they will cost you more on account of employer NICs, and the employee will get less.

Check your contracts

While on this note, consider checking your contracts, including legacy contracts, to see which have PILON provisions and which don’t. As any perceived tax advantage for omitting a PILON has fallen away, it makes sense to include them in contracts going forward. This is a must anyway if you want to preserve any restrictive covenants in the event of (actual or alleged) wrongful termination. There is a potential mitigation downside (no employee duty to mitigate loss in what would have been the notice period), but that can be built into the terms of any settlement.

Doing the maths

Calculators at the ready? From 6 April, if an employee gets a “termination award” and they have unworked notice, HMRC deems a slice of it to be taxable and NIC-able “post-employment notice pay” (‘PENP’).

You, or your payroll teams, must calculate the PENP if making a contractual or non-contractual PILON as part of that termination award. Essentially this involves calculating deemed unworked notice pay – the basic pay that the employee would have received if they had worked (the longer of) contractual or statutory notice – and deducting any contractual PILON paid.

There are several steps and a complex statutory formula for working this out. The calculation is more straightforward for monthly paid employees with notice and unworked notice in whole months; for those paid weekly or with notice in weeks, it is less so as you have to calculate an average daily pay rate. The specifics are in the tax legislation, and there is also HMRC guidance, but here is a summary with worked examples for: Sue, paid monthly – non-contractual PILON; Bob, paid weekly – contractual PILON; and Sally, paid monthly – salary sacrifice and contractual PILON.

Taxing the balance

There should often be no further tax to pay on contractual PILONs. They are already taxed as earnings and deducted from the deemed unworked notice pay figure. However, you still need to do the calculation as the value of any salary sacrifice arrangement, which must be added to basic pay, could make a difference.

Having established the PENP, the remainder of the termination award (assuming it’s not otherwise taxable) can attract the £30,000 tax and full NICs exemptions. But from 6 April 2019, employer NICs will be payable on any part of a payment exceeding £30,000 – potentially a significant extra cost.

Taking a stance

This could, of course, have a knock-on effect for exit negotiations. The “carrot” of tax-free non-contractual PILONs can no longer be a bargaining point. Employees will push for clarity on the tax position in negotiations, as they’ll want to know what they are getting and will most likely be giving a tax indemnity as part of any settlement. They might also up their financial demands to compensate for the extra tax and employee NICs liability.

But be robust – tax is tax after all, and you are legally required to deduct and account for it. The HMRC can pursue you if you don’t and impose penalties and interest for late payment. It is easier to withhold the correct amounts in the first place than to seek to recover them from an employee who has moved on. And with the broadly cast corporate criminal offence of failing to prevent the facilitation of tax evasion carrying the risk of unlimited fines, compliance will be key.

Comments published on Employment Talk do not necessarily reflect the views of Allen & Overy.

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