When things haven’t ended well with an employee, the thought of sharing the office whilst they work their notice period can be awkward to say the least. Bad feeling in the workplace is never good, and it can have a huge impact on staff morale and productivity. In these cases, a payment in lieu of notice may be used; allowing the employee to be payed their usual salary and possibly even benefits throughout their notice period without them actually coming to work in that time.

As of April 6^th, 2018, payments in lieu of notice are no longer tax free. If you’re an employer, you will now need to pay Income Tax and Class 1 National Insurance on all termination payments you pay.

Payments in lieu of notice – how does payment in lieu of notice work?

Payment in lieu of notice – or PILON for short – refers to the wages your staff member is paid without having to work their notice period. This is a way to continue to pay your employee’s salary without them coming in to work.

This may sound like an unfair deal on the side of the employer, but it is a popular feature in many settlement agreements as it means you can still meet your legal obligations without having to work with an employee once the relationship has broken down.

For example, if a member of staff had a three month notice period but you wanted today to be their last day of employment, you would continue to pay their wages in lieu of notice for three months without them needing to come back into the office at all.

This is slightly different to garden leave. This is where your employee is told not to work but they are also not allowed to take another job with a competitor during this time. The employee must adhere to company policies and conditions of employment whilst on garden leave, such as confidentiality.

With garden leave however, the member of staff is still technically employed so you can theoretically call on them to do more work. If you are paying them in lieu of notice, they are no longer your employee.

Payments in lieu of notice –  changes to tax on PILON 2018

Before last month, if an employee’s contract allowed you to pay them in lieu of notice, this payment would be taxable. If their employment contract did not allow you to make a PILON payment, this would be tax-free up to a limit of £30,000; including any other kind of associated compensation.

However, new legislation brought in on the 6^th April now state that you must account for any basic pay your employee would have received if they had been allowed to work their notice.

This basic pay during their notice period is treated as earnings whether the member of staff is actually working for you in this time or not. That means the sum is subject to both tax and national insurance contributions, even if their contract does not include a specific PILON provision.

Payments in lieu of notice – why have the changes been made?

The latest changes to tax around payments in lieu come both as an attempt to reduce the instances of employers manipulating the rules to minimise their tax deductions and to help simplify the tax system – though many argue it actually makes things more complicated.

In the past, many companies have been caught out either not giving notice or making payments in lieu without a contractual right to do so. Employers have also been found trying to pay wages in lieu as a termination payment without any deduction of tax up to £30,000.

That’s because termination payments that are not otherwise taxable also have a £30,000 tax exemption in the cases of redundancy pay. HMRC has since caught on to these tax-evading practices, bringing in the new rules as a way of taxing these ‘disguised’ notice payments.

Payments in lieu of notice – what do the PILON changes mean for your business?

HM Revenue and Customs have also created a new category known as ‘post-employment notice pay’ as another attempt at removing common loopholes used by employers. These payments will not be tax-free either but will make things a little harder for employers when deciding what element of their payments fall into this category.

Despite constant efforts towards tax simplification, these new rules will no doubt increase the payroll and administrative burden when it comes to determining which termination payments will benefit from the threshold and which will not.

The new process will involve difficult calculations regarding how much of the payment will be taxed and whether or not it will be subject to PAYE deductions, so it is important that you consult your accountant when it comes to termination payments and payments in lieu of notice to ensure accuracy and that you make the most tax-efficient choice.

Payments in lieu of notice – speak to your Burton Beavan accountant today

The HMRC website has further guidance around the changes to termination payments and PILON which you can read here. However, if you want to find out more about how your termination arrangements will be affected by the new rules, speak to the experts at Burton Beavan for professional advice and guidance today on 01606 333900 or email hello@burtonbeavan.co.uk