What will employers pay for a Settlement Agreement? A Taxing Issue…
October 5, 2016
On 10 August 2016, the Government published a consultation paper on the taxation of Settlement Agreements. The snappily titled “Simplification of the tax and National Insurance treatment of termination payments: government response and consultation on draft legislation” is taking responses until 5 October 2016.
So why are we having the consultation and what is the likely outcome?
The Current Position
Presently, if a company exits an employee via a Settlement Agreement, there are various mechanisms which allow any monies passing between the parties to be paid in a tax efficient way. In particular: –
- If an employee is receiving a payment in lieu of their notice, and they do not have a clause in their employment contract which allows an employer to make this payment, then that PILON can be paid without deduction from tax;
- A company can apportion a sum of money to injury to feelings and, if so, that sum of money will not be taxable either; and
- An employer is not required to pay national insurance contributions on certain parts of “ex gratia payments” to employers.
In practice, this means that where a Settlement Agreement is entered into there is often a debate (argument!) between respective lawyers about which payments are taxable and which aren’t. It also creates a slightly odd scenario where you could have two colleagues leaving a company in exactly the same way but one gets more money because of the absence of a clause in their employment contract. Naturally, it also means that less money is paid in tax to the HRMC.
April 2018 onwards?
The Government has launched a consultation paper about changing the current position. This follows previous consultation around the same issue.
In particular it is proposed that: –
- All PILONS are taxable in full, regardless of whether there is a PILON clause in the contract or not;
- Remove the ability whereby injury to feelings payments are tax free;
- Broaden the circumstances in which national insurance contributions are paid.
The Government’s primary concern, which is well founded, is that the current system is complicated and is open to manipulation by employers and indeed employees. It is certain that there will be some changes following this consultation. Whilst not ideal for all (particularly those without PILON clauses!) it will simplify the current position which, as the title of the consultation makes clear, is part of the plan in any event.