Taxation of termination payments: major changes now in effect

Some of the key changes came into effect from April 2018 and have a major impact on the way that termination payments are taxed from that date.

Specifically:

• Employers are now required to subject to tax and class 1 NICs an amount equivalent to the employee's basic pay for any periods of unserved notice, even if the employment contract does not contain a payment in lieu of notice clause. There is a detailed formula for calculating the sum which is subject to tax and NICs.

• The Government has clarified that payments for injury to feelings fall outside the tax exemption for injury payments, except where the injury amounts to a psychiatric injury or other recognised medical condition.

Further changes are expected to come into force from April 2019, including a requirement to pay employer's NICs in respect of termination payments to the extent they exceed £30,000.

Taxation of injury to feelings awards

The taxation of payments for injury to feelings was also recently addressed by the Court of Appeal in Moorthy v HMRC [2018] EWCA Civ 847. The case pre-dates the legislative changes but reinforces the position.

The Court of Appeal held that discrimination-related compensation for injured feelings in connection with employment termination was taxable as a termination payment but, reversing the decision of the Upper Tribunal, on the facts, it fell within the exception for death, disability or injury payments.

Where employers are negotiating settlement agreements with employees and there is a sum to be paid in respect of injury to feelings which the parties have agreed will not be paid subject to tax, the agreement should specifically set out the nature of the injury.