Tax changes means you will have to change your approach to settlement agreements

23 March 2018

With effect from 6 April 2018, all notice payments must be made subject to tax and National Insurance deductions.

Currently, the presence of a payment in lieu of notice (PILON) clause determines whether notice pay is taxable as a contractual payment or, in the absence of a PILON clause, whether it can be paid as part of a tax free compensation payment. However, it is not always clear cut. Questions arise over the drafting of the PILON clause, especially those that purport to be ‘discretionary’. There may also be a risk that HMRC could enforce what is known as an ‘auto-PILON’ where payments in lieu of notice are an automatic response to notice of termination being given or received.

HMRC has changed this by introducing a new rule which requires all notice pay to be paid subject to PAYE deductions from 6 April 2018 – known as “post-employment notice pay” (PENP).

This will effect settlement negotiations where the ability to pay notice pay as part of a tax free payment has, until now, been a benefit that employers often pass on to their employees without having to dig deep into their pockets to enhance their ordinary contractual payments. This will no longer be able to happen. Employers must deduct tax and National Insurance contributions from any PENP. The calculation of the PENP depends on a number of factors, such as whether an employee is paid monthly or weekly and whether the notice period is expressed in months or weeks.

This change in the taxable status of notice pay means that settlement agreements will need to set out any payment in lieu of notice separately or, alternatively and if accurate to do so, the dates on which the notice period has been worked in part or in full. Adjustments will also have to be made to the calculation of notice pay when an employee participates in a salary sacrifice scheme, as notice pay will be based on an employee’s pre-sacrifice rate of pay.

Employers should also note that, with effect from 6 April 2018, compensation for injury to feelings in discrimination cases will no longer benefit from the tax free exemption unless it relates to a psychiatric injury or another recognised medical condition.

Further changes will occur in April 2019 when termination payments will be subject to employer’s National Insurance contributions on any sum over and above the £30,000 tax free exemption. .

By Michelle Tudor

For further advice on the above topics, please call us on 01483 543210 or alternatively email

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