Muras Matters: New Rules on Taxation of Termination Payments

New Rules on Taxation of

Termination Payments



From 6 April 2018 the rules surrounding termination payments changed. Previously termination payments were broadly only subject to income tax and Class 1 National Insurance Contributions (“NICs”) if they were contractual payments along with a few other exceptions.

However, from 6 April 2018 all termination payments for payments in lieu of notice, rather than just contractual payments, are to be treated as taxable earnings.


From 6 April 2018 the new concept of post-employment notice pay (PENP) was introduced which changes the way in which payments in lieu of notice are treated for tax purposes. Previously the tax treatment of termination payments largely depended on whether it was contractual, customary, or paid automatically which required scrutiny of the employee’s contract and the employer’s practices. Payments not falling into these categories were then generally eligible for a £30,000 tax free element and fully exempt from NICs with no upper limit.

Under the new rules all termination payments are to be treated the same, with employers required to identify the element of the termination award which represents the normal pay that the employee would have received during the notice period had the employment not been terminated (the PENP) and ensure this is subject to tax and NI under the PAYE system.

This is not as straightforward as it appears since there is a complicated legislative formula which must be used in order to calculate the PENP. The formula applies even if the termination payment is contractual.

The PENP is then compared to the relevant termination award, which is essentially the element of the termination payment which is not a statutory redundancy payment. If the PENP is less than the total amount of the relevant termination award, the part equal to the PENP is taxed as earnings with the excess then benefitting from the £30,000 exemption. Otherwise the whole of the termination payment is taxable.

The new rules apply based on the date that the employment ceases rather than when the payment is made. Basically, if the employment ends on or after 6 April 2018 then the termination payment will be subject to the new rules.

The other main change is that the foreign service relief previously available has been removed for all UK residents, apart from seafarers.

Further changes are also due to come into effect from 6 April 2019, when all termination payments above £30,000 will also be subject to employer’s Class 1A NIC, further increasing the NIC costs for employers paying larger termination payments.

The above is only an outline of the changes that have come into effect and if you would like further information on termination payments or are considering making a termination payment then please contact our Tax Director, Jenny Marks.

To see our other news items please visit our Muras Baker Jones – Blog.