When negotiating a settlement agreement we are sometimes asked if it possible to transfer the sum of the contractual payment in lieu of notice (PILON) to a pension fund? Often this type of request is generally made when there is an ex-gratia severance in excess of £30,000 and an employee wants to save on any tax due over this sum.
When considering any such request it’s important to consider first if there any contractual implications, alongside any tax/National Insurance position on the sum the employee is requesting to be transferred to their pension fund.
If HMRC agree the payment has been genuinely sacrificed then it might be possible to be paid into the pension scheme tax-free under section 408 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003). If HMRC don’t agree, and in their view the payment has been paid into a pension scheme, rather than sacrificed, then the payment would fall to be taxed in the usual manner.
It won’t come as a surprise to learn there is no straightforward answer. The introduction from 6 April 2018 of the post-employment notice pay (PENP) rules means that, with effect from that date, employers must determine whether a portion of certain payments made on termination of an employee's employment must be taxed as earnings and subject to tax and class 1 NICs. When a sacrifice into a pension scheme is being requested, and in circumstances where a PENP calculation is required, there is still no guarantee HMRC will agree with the outcome ultimately agreed between the employer and employee.
By seeking to assist an employee an employer may find themselves having to justify their actions to HMRC if proper consideration of HMRC guidelines has not been considered and subsequently followed. Individual circumstances will of course vary and where there is doubt over the position then consulting an employment and tax specialist to provide bespoke advice may just prove invaluable to both employer and employee. This is particularly so where employees’ entering into a settlement agreement are looking to maximise their gross sum and leave employers’ to find out the hard way that those employee tax indemnities in the settlement agreement are of little use when you need them.
NB: Chris Piggott is a Partner in the Employment Division of mfg Solicitors LLP having expertise in employment law. He is not a taxation expert and obtaining tax advice from a tax specialist or accountant should always be considered before any arrangement, as illustrated above, is agreed upon between employers and employees.
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