Termination payments in the public sector – an update

27 November 2017

This article was featured in the December 2017/January 2018 issue of the magazine.

John Harling, principal employment taxes consultant at PSTAX, discusses impending important changes 

Changes to the tax and National Insurance contributions (NICs) treatment of payments on redundancy and termination are due to come into effect from next year.  Additionally, there are still plans to introduce a cap on exit payments in the public sector and a requirement for public sector employees to repay exit payments in certain circumstances. However, the details and timing of these particular plans are yet to be finalised.

Tax/NICs changes

Under the Finance Bill 2017 which is currently going through Parliament, the changes set out below will apply to payments on redundancy/termination made on or after 6 April 2018. 

For many years, employers have struggled with the tax/NICs treatment of payments in lieu of notice (PILONs), which varies according to the character of the PILON itself.  Therefore, from 6 April 2018, it will make no difference whether the payment is contractual or non-contractual and whether it is automatic/customary or purely discretionary. This will mean that the ‘basic pay’ that the employee would have received had they worked out their notice is subject to tax in full regardless of whether there is a clause in the employment contract giving the employer the right to terminate the employee’s employment by making a PILON. ‘Basic pay’ for these purposes is the employee’s pay before any salary sacrifice adjustment in the pay period immediately prior to the date on which notice is given or, if no notice is given, the date the employment terminates. It is intended that the definition of basic pay would exclude bonuses, commission payments, allowances and benefits in kind. It had been intended that this would also apply to the NICs treatment of PILONs from April; however, at the time of writing this article, we await confirmation of this in light of the recent announcement in delaying the National Insurance Contributions Bill to 2018 (see below)

Given that the new tax and, subject to confirmation, NICs treatment of PILONs will be much less beneficial than in respect of other forms of termination payment, it remains to be seen whether public bodies will seek to structure packages in a tax effective manner with a view to saving employer NICs costs and/or reducing the overall termination package costs.

The exemption for payments relating to disability will remain in place, but will not apply to compensation for injured feelings, unless the injured feelings constitute a psychiatric injury or other recognised medical condition. The disability exemption provides a 100% tax exemption for termination payments – there is no £30,000 threshold – made only on account of the employee’s disability or injury where the disability or injury prevents the employee from carrying out the duties of their employment. This availability of this exemption is reliant on medical and other evidence to prove that the payment relates solely to the disability/injury.

It had also been intended that from April 2018 there would be a closer alignment of the tax and NICs rules in respect of termination payments and the £30,000 threshold, which would mean that a termination payment which benefits from the £30,000 tax exemption would be subject to income tax and employer Class 1A NICs (rather than Class 1) on any amounts over £30,000.   However, the government announced on 2 November 2017 that a National Insurance Contributions Bill will now be introduced in 2018 with the intention that this change will now take effect from April 2019.  We understand that the existing employee’s NIC exemption will still be retained, even if the payment exceeds £30,000. As mentioned above, we await confirmation regarding whether the change in the tax treatment of PILONs will be aligned with a change to the NICs treatment or whether the NICs change will be delayed to 2019.


...no difference whether the payment is contractual or non-contractual and whether it is automatic/customary or purely discretionary


Exit cap and repayments provisions

Whilst it is understood that the government still plans to introduce a cap of £95,000 on exit payments in the public sector, no regulations yet exist to create the cap itself. Whilst the UK Treasury, Scottish and Welsh Ministers have had the power to bring forward regulations since 1 February 2017, they have not yet chosen to do so.

In addition, at the time of writing this article, no clear timetable appears to be in place to bring these proposed changes into effect. Rumours are circulating that this could be happening in April 2018 which would align with the tax-related changes commented on above.

For the purposes of calculating the cap it is understood that it will include any payment:

  • on account of dismissal by reason of redundancy

  • on voluntary exit

  • to reduce or eliminate an actuarial reduction to a pension on early retirement or in respect of the cost to a pension scheme of such a reduction not being made

  • that is ex gratia

  • in respect of an outstanding entitlement

  • of compensation under the terms of a contract

  • in lieu of notice

  • in the form of shares or share options.

Following a consultation in 2016 the government said that it expected different departments to produce their own plans in respect of the cap from mid 2017 onwards. However, at this stage there is no clear evidence that such plans have been finalised.

In addition to the above, there is also a Private Members Bill currently with Parliament called the Public Sector Exit Payments (Limitations) Bill 2017. This was introduced into Parliament on 5 September 2017 and is due to have a second reading on 1 December 2017. No details of the contents of the bill have been published.  This casts even more doubt on what the government’s intentions are on this particular matter.


...precious little information about the plans for public sector employees being required to repay exit payments above £80,000... 


Repayment provisions

Since the idea was first mooted almost two years ago, there has been precious little information about the plans for public sector employees being required to repay exit payments above £80,000 if they are re-employed by another public body within twelve months of leaving. It is not clear whether the government still plans to introduce this change; however, as it has not been expressly stated that these plans have been dropped, it must be assumed for now that this will still go ahead.

Payroll managers in the public sector should brace themselves for another wide-ranging set of legislative changes potentially from April 2018 requiring a significant amount of research, training and time input from early next year.


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*content correct at time of publishing