How to Stay Safe from HMRC
27 May 15 | By: Jas Jhooty
Many employers automatically assume that they can pay the first £30,000 of a termination payment tax & NIC free. This is a popular misconception that can leave the employer exposed to penalties from HMRC who specifically target termination payments for review at their Know your Customer meetings.
In our experience the most commonly misunderstood aspect of an employee’s redundancy/termination package is the correct tax treatment of the Payment in Lieu of Notice (PILON).
A PILON is a payment that employers make to an employee to bring an end to their employment. The PILON is made instead of giving them their notice period. The effects of this are that the employment ends immediately and the payment compensates the employee for what they would have earned during the notice period.
A PILON can include any of the following:
An employer who has established a practice of making non-contractual PILONs may be deemed to have created an implied term in the employment contract, and subsequent payments to other employees in the same situation are likely to be taxable. HMRC distinguishes between the case where an employer automatically makes a payment and an employer who undertakes a genuine critical assessment of each individual employee’s circumstances.
The tax treatment of PILONs has been the subject of many interpretative tax law cases.
At the employer’s discretion
If a contractual PILON is subject to the employer’s discretion, the payment will constitute earnings, because it is paid in lieu of salary that the employee should otherwise have received, and the contract is not breached.
No Identifiable breach
In a similar case involving a compromise agreement on termination, a lump sum was paid, and as there was no identifiable breach of the contract, the discretionary PILON was taxable (even though the payment did not follow the amount or form specified in the contract).
Employer breaks the contract of employment
Where the employer ignores the contract by failing to give notice, and fails to make payment, any compensation payable to the employee for breach of contract is not a discretionary PILON and is not earnings from employment.
If a PILON is made in circumstances contemplated in the employment contract, the payment must be taxable as earnings. In this particular case, although the contract itself did not give the employer the right to dismiss employees on the payment of a PILON, there was a reference to a memorandum of understanding agreed between the employer and trade union. It was this document which contained provisions relating to redundancy, notice periods and PILONS.
This is very tricky area that is often overlooked by employment lawyers at the time when compromise agreements are being drafted. A recent tax case Goldman v Revenue and Customs Commissioners  UKFTT 313 illustrates the consequences of getting it wrong.
Our consultants have considerable experience of reviewing contracts of employment and drafting effective redundancy policies to maximise tax efficiencies. We also regularly obtain clearance from HMRC on the taxable position before any payments are made. Our approach results in savings to both the employer and any affected employees.
Please do not hesitate to contact us if you want assistance on this or any other employment tax matter.