NIM13201 - Class 1A NICs: liability for Class 1A NICs: Class 1A NICs on termination awards: introduction

With effect from 6 April 2020, the NICs (Termination Awards and Sporting Testimonials) Act 2019 (the Act) places an employers’ (Class 1A) NICs charge on payments made on termination of employment which are:

  • in excess of £30,000
  • taxed under s403 ITEPA 2003 and
  • not already charged to Class 1 NICs as earnings, mirroring the income tax treatment.

The new Class 1A liability does not affect individuals as it is paid by the employer. The employer must pay and report Class 1A payments made on termination awards in real time, through their RTI returns.

See NIM13203 for more details.

Background

The Office of Tax Simplification (OTS) stated during their 2013-14 review of the tax and NICs treatment of termination payments that

“the well-advised can often end up better off than the unadvised, as they are more able to structure their employment contract (or, indeed, their termination payment) to achieve the better tax treatment”

The main reason that businesses had an incentive to do this was the absence of employers’ National Insurance contributions on termination awards of any size. Some awards were taxed as earnings, others were taxed only above £30,000 and still others were completely tax and NICs free. This complexity left the tax system open to manipulation where employers and employees were looking to achieve a tax advantage.

The government announced at Summer Budget 2015 that it would consult on simplifying that tax and NICs treatment of termination awards.

Following the consultation, at Budget 2016 the government announced the reform of the tax and NICs treatment of termination awards and published draft legislation for consultation.

The income tax measures announced at Budget 2016 were legislated for in Finance Act 2017 and took effect from April 2018. The government confirmed at Budget 2018 that the associated reforms to NICs legislation would be in place for April 2020.

Section 5 of Finance Act 2017 made changes to the taxation of termination awards by inserting new sections 402A to 402E into ITEPA 2003. The effect of these new sections is that some awards that previously formed part of a termination payment and were therefore not taxable until a £30,000 threshold was exceeded are now treated as general earnings. They are now taxable without any threshold applying.

Sections 402B to 402E ITEPA 2003 set out calculations for working out which parts of the termination award should be treated as general earnings. In essence, all Payments in Lieu of Notice (PILONs) became taxable as earnings and will not benefit from the £30,000 tax-free threshold.

With effect from 6 April 2020 The Social Security (Contributions) (Amendment No. 2) Regulations 2018 made changes to NICs legislation to mirror the tax position for PILONs and applied a Class 1 (employee and employer) NICs liability to termination awards that fall within new section 402B ITEPA 2003 by treating such payments as earnings for NICs.

The Act provides that termination awards that are not earnings which are currently charged to income tax on amounts that exceed £30,000 but remain exempt from Class 1 (employee and employer) NICs, there will be a corresponding liability to Class 1A employer NICs. This means that a 13.8% employer NICs charge will be applied to income derived from a termination award that is already subject to income tax but not Class 1 NICs.

As part of the Health and Social Care Levy, for termination awards that are paid covering the earnings period between 6 April 2022 and 5 November 2022, a 15.05% employer NICs charge will be applied to these payments. This reverts back to 13.8% from 6 November 2022. See NIM01600 for more information.

The Act:

  • specifies that the rate of Class 1A employer NICs payable on termination awards will be the same as the prevailing rate payable by employers
  • prevents, for the avoidance of doubt, the double charging of NICs if the termination award is already liable to employee and employer Class 1 NICs
  • does not introduce a NICs liability on the employee, there remains an unlimited employee NICs exemption on termination awards
  • does not reduce or introduce new powers to change the existing £30,000 threshold below which termination awards are entirely tax and NICs free
  • does not go beyond mirroring the effect of the income tax rules with respect to the scope of this change - the rules that determine liability to income tax will apply directly in calculating the amount of Class 1A NICs payable on termination awards above £30,000.

Important note

Existing Class 1A National Insurance contributions, paid on benefits in kind listed on form P11D(b) are unaffected by this change. See NIM13000 for more information.