Changes to the taxation of UK employment termination payments

March 15, 2018

New rules to the taxation of termination payments to employees in the UK will apply from 6 April 2018. These rules will increase the income tax and national insurance liabilities in relation to such payments as well as increase the complexity of the calculation of the applicable tax. 


Employers need to be aware of the new rules coming into force in April in relation to the tax treatment of termination payments. The February edition of HMRC’s Employer Bulletin confirmed that these new rules will apply to payments or benefits received on or after 6 April 2018 where the employment is also ended on or after that date. 

The new rules treat as taxable – and subject to Class 1 National Insurance Contributions – the portion of a severance payment which is attributable to the basic pay element of any part of the employee’s notice period to the extent that the employee does not work out the applicable contractual or statutory minimum notice period. To the extent that a severance package includes a statutory redundancy payment or “approved contractual pay” under redundancy arrangements specifically approved by HMRC, a termination payment will remain tax free as will payments to registered pension schemes falling within the applicable limits. To the extent that a payment in lieu of notice is made pursuant to a contractual payment in lieu of notice provision – or by way of what HMRC categorises, due to the employer’s established approach to terminations, as an “auto-PILON” - the payment the employee receives will be taxable as earnings as is the case currently. 

The rules governing the new tax treatment are detailed and this OnPoint provides only a very broad overview. Further detail will be provided by HMRC in due course in its Employment Income Manual. A more detailed analysis of the new rules by Charles Wynn-Evans of Dechert, “Taxing times for termination payments”, including some worked examples, is now available. This article was first published in Employment Law Journal (March 2018) at

Taxing basic pay in respect of the employee’s notice period 

This new tax treatment will operate by reference to the concept of the “post-employment notice payment” (“PENP”):- 

  • If the PENP is greater than or equal to the total of the employee’s termination award then the full termination award is treated as taxable earnings. 
  • If the PENP is greater than nil but is less than employee’s relevant termination award, the part of the termination award that is equal to the PENP is treated as taxable earnings. 

The PENP is based on the employee’s “basic pay”. This is employment income disregarding overtime, bonuses, commissions, gratuities, allowances, termination awards, benefits in kind and other amounts treated as earnings (such as share-based earnings). Dependent on whether the employee is paid monthly and whether the unworked notice period can be calculated in complete months, different formulae are applied in the calculation of the PENP. 

Employees not monthly paid 

The statutory formula determining the PENP will be ((BP x D)/P) – T where: 

  • BP is the employee’s basic pay from his or her employment in respect of the last pay period to end before the “trigger date” (which is essentially the termination date). 
  • P is the number of days in the pay period. 
  • D is the number of the days in the “post-employment notice period” (which is essentially the unworked portion of the employee’s notice period). 
  • T is the total of payments or benefits made to the employee on termination which are taxable - for example, a taxable payment in lieu of notice - or do not constitute either a bonus payable for termination of employment or payment in respect of holiday entitlement prior to termination. 

Monthly paid employees 

If the employee is monthly paid, the individual’s notice period is expressed in months and the employee is either terminated immediately or the unworked notice period is a whole number of months then the formula is BP x D – T where:- 

  • BP is the basic pay for the last pay period to end before notice is given. 
  • D is the number of months in the post-employment notice period – in effect this is the number of months of the notice period which are not worked. 
  • T is as defined above. 

Salary sacrifice arrangements 

Under the new rules, if the individual's employment terminates earlier than the end of the notice period with a PILON being made, the amount of salary which would otherwise have been sacrificed during the unworked notice period will count as “basic pay” and be taxable and subject to Class I NICs. This can increase the overall tax liability. 

Other provisions 

Specific provisions in the revised legislation apply in relation to payments in respect of the balance of a fixed term contract. There are also anti-avoidance provisions providing that, where arrangements are put in place to render the PENP lower than it otherwise would be, the PENP is deemed to be the amount it would have been but for those avoidance arrangements. 

Foreign service relief abolished 

Currently, if a UK resident employee has spent more than three quarters of his or her employment performing his or her duties abroad or has spent at least the previous ten years abroad or has spent ten of the last twenty years working abroad, “foreign service relief” applies to except a termination payment from income tax in full or, if the relevant criteria are not met fully, on a proportionate basis. With effect from 6 April 2018 it is proposed that foreign service relief will no longer be available other than in respect of certain seafarers – only employees (or former employees) who are not resident in the UK for the tax year when the termination of the employee’s employment occurs will be potentially eligible for foreign service relief. 

Future NIC changes 

It is anticipated that, with effect from 6 April 2019, employer – but not employee – NICs will be payable in respect of the excess of a termination award over £30,000. Employers should keep an eye out for the detail of these proposed changes as and when they are finalised. 


Employers considering terminating the employment of employees in the coming weeks should consider whether the parties’ best interests are served by arranging termination ahead of the change to the tax regime. Once the new rules are in force employers will need to ensure that they apply the new tax treatment correctly and update their internal processes and potentially their severance documentation appropriately. Negotiations and discussions with departing employees may become more complex in light of the new rules but employers will still in any vent need to assess the structuring of departure arrangements carefully to ensure that the proper tax treatment is applied.

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