Is it possible to make a tax-free termination payment under a settlement agreement, if there is no mention of a PILON in the agreement and no PILON clause in the contract?

The changes to payments in lieu of notice which came into effect on 6^th April 2018, effectively mean that where any part of a termination payment relates to notice pay, this is subject to tax and NICs as earnings and is no longer dependent on whether there is a PILON clause in the contract or not. These provisions require employers to split a termination award between amounts treated as earnings (section 402B, ITEPA 2003) and amounts benefitting from the £30,000 exemption (section 403, ITEPA 2003). In other words, employers must treat a slice of a termination award, which reflects basic pay for any part of a notice period that is not served, as earnings and subject that slice to tax and NICs.

Therefore, if any part of the termination payment being made under a settlement agreement after 6 April 2018 relates to notice, this will need to be taxed (and subject to NICs) even if there is no contractual PILON and the agreement does not categorise the payment as a notice payment. The risk of failing to separate the components of the termination payment in the settlement agreement is that HMRC can question the tax status of the payment and where an attempt is made to make the whole payment tax-free, it can subsequently decide that part (or whole) of the payment was indeed taxable as earnings.

It is therefore important to ensure settlement agreements are drafted carefully to reflect the changes in relation to termination payments. Please do contact us if you require assistance.