Effective April 6, 2018, there will be an important change to the way termination payments are taxed. New tax rules, which aim to simplify the taxation of termination payments, will require that income tax and National Insurance contributions (NICs) be paid for all payments that relate to the notice period. These payments are mandatory regardless of whether there is a payment in lieu of notice clause in the contract of employment. The change will apply to all terminations effective on or after 6 April.

Upon employment termination, employers must ensure that taxes and NICs are deducted correctly. Moreover, any employer’s NICs—which are calculated by multiplying the earnings or profits plus certain non-cash benefits by the relevant percentage (13.8 percent)—must be paid. This is often an important consideration in the context of considering the cost of settlements, and employers will generally be liable for any taxes and NICs not deducted, plus interest and penalties.

Currently, employers can avoid paying taxes upon giving notice if there is not a “payment in lieu of notice” clause in an employee’s contract or in the absence of any regular history of making payments in lieu of notice. Technically, the payment is then damages for breach of contract and can be part of the £30,000 tax-fee entitlement that applies to non-contractual payments. An example is ex-gratia payments received in connection with terminations and redundancies.

The new legislation details how to identify and calculate any payments that should be treated as “post-employment notice pay.” This in turn clarifies how to determine the amount of the termination payment that is subject to taxes and NICs. The intention is to tax, as “earnings” the basic pay that the employee would have earned had the employee worked his or her notice period. This excludes benefits, bonuses, commissions, allowances, and share options.

By treating all payments relating to the notice period as post-employment notice pay subject to income tax and NICs, the new legislation and accompanying guidance make it clear that in all cases in which an employee leaves without working his or her notice entitlement period, the notice pay due to the employee will be taxed. As a result of the new legislation, it will not be permissible to try to structure the employment contract otherwise.

A second key change is that employers’ National Insurance contributions will be due on these notice payments and other elements of termination payments that are subject to income tax. In addition, from April 2019, employers’ NICs will be payable on payments above £30,000, which are currently only subject to income tax. Basically, sums that are chargeable to income tax will also be chargeable to employers’ National Insurance contributions.


In addition to the increased liabilities for NIC payments, employers may also be faced with situations in which employees try to negotiate for higher termination payments in order to compensate for what they will lose, e.g. grossing up to take account of taxes. HM Revenue & Customs has confirmed that the new legislation applies to terminations made on or after 6 April 2018.  Payments made for terminations prior to 6 April 2018 will be subject to the old legislation, even if they are paid after that date.

Written by Justin T. Tarka of Ogletree Deakins