Tax on Termination UK

A guide on what tax employers should be paying on payments made when terminating employees

Many companies are under the misconception that whenever they terminate an employee, all related termination costs are entitled to a considerable exemption from tax. But one can only apply for this exemption if there is no other way to charge this cost to income tax.

When should tax be paid?

As a general rule, income tax and national insurance contributions (NICs) are due on all payments made based on an employer’s contractual obligations.

Tax must be paid on other amounts paid on termination only if the amount paid exceeds £30,000. Such costs may also be exempt from payment of National Insurance Contributions.

There are a number of situations where this generic classification does not apply – therefore this classification should not be taken as the rule.


A restrictive covenant is a contractual agreement where the employee agrees to either take or abstain from a specific action or behaviour. Payments may be made because of this type of agreement that may be made to ensure confidentiality of company information and to limit the possibility of potential competitive advantage when for example, an employee is poached by competitors. In this case, tax and NICs must be paid on such payments made.

Tax and National Insurance Contributions must also be paid when payments are made on the retirement of an employee.

In the case of payments made due to redundancy, tax and NICs must only be paid on amounts exceeding £30,000, as long as it is a bona fide redundancy.

Also, where payments are made to employees with a disability as an allowance for said disability, no tax or NICs are due. Certain limitations may exist, so it is important to check specific required conditions for said exemption.

Notice Payments

Since the 6 April 2018 a new legislation is now in force and this stipulates that payments made instead of notice period will also be eligible for income tax and National Insurance Contributions.

If there was no clause specifying the payment in lieu of notice (PILON) in the employee’s contract of employment and the employer decided to ask the employee to leave before working out his or her notice period, and paid the employee off, before the enactment of this recent law, tax and NICs would not previously have been due. Any amounts over £30,000 would be subject to tax but NICs would not have to be paid.

Under the new legislation, tax and NICs (both employer and employee) must be paid on all amounts relating to notice payments, irrespective of whether a PILON was included in their employment contract or not. Additionally, the new legislation also specifies that NICs must also be paid on any other payments made on termination that were not part of the contract for any amounts over £30,000.

Whether to include PILONs in employment contracts

In certain cases, employers may have purposely not included a payment in lieu of notice clause in their employment contract to give them more latitude when negotiating an employee’s termination or exit strategy. This is risky because if an employer makes a PILON when no such clause is included in the employment contract, the employer will technically be breaching said contract. The employee may make the case that any restrictive clauses made are no longer enforceable since the agreement has been breached by the employer.

Payment in lieu of notice clauses should be in all employment contracts as a matter of course since any benefit from excluding such a clause has now been eliminated. This will avoid the issue of claims of breach of contract if such a payment is then made.


About the author
Leave Comment

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

clear formSubmit