Taxation of non-contractual notice pay: the revised proposals

The Government has now published a revised draft of new legislation which removes the current tax exemption from non-contractual notice pay, where this is part of a termination payment worth less than £30,000. This change will take effect in April 2018, along with a number of other changes to the taxation of termination payments. These include removing the exemption for employer’s national insurance contributions where the termination payment is over £30,000.

The original proposals were published in September 2016 and were revised following consultation last December. The latest version of these proposals (with some further changes) has been published as clause 5 of the Finance (No 2) Bill 2017. The idea is to address the anomaly which allows non-contractual payments in lieu of notice to escape income tax and national insurance, where these are structured to fall within the scope of the £30,000 tax exemption for termination payments.

In the explanatory notes to the Bill, the Government describes its plans as follows:

“All employees will pay tax and Class 1 NICs on the amount of basic pay that they would have received if they had worked their notice in full, even if they are not paid a contractual payment in lieu of notice.”

The provisions which define how much employees would have received if they had worked their notice in full are complex. However as a general rule it involves a two stage calculation:

• First, calculate a daily basic rate of pay by reference to the last completed pay period;
• Secondly, multiply this daily rate by the number of days between the date the employment ends and the date the full contractual notice would have expired.

In practice, it can get a little more complicated than that. For example, if there are any salary sacrifice arrangements, the basic pay will need to be adjusted back to what it would have been without such arrangements. In addition, employers will get credit for any elements of the termination payment which are already subject to tax. There is also special protection for statutory redundancy payments, to ensure their tax treatment is not affected by these changes.

Broadly speaking, any element of the termination payment that remains once the notional notice pay has been deducted will continue to attract the £30,000 exemption. Employers making contractual payments in lieu of notice, which are already subject to tax and national insurance contributions, will not in practice be affected by this particular change.