Termination payments: The new rules

folded measuring stick

The new rules and definitions surrounding termination payments may have an impact on how packages are put together in the future, writes Julie Hodgskin.


Finance (No 2) Act 2017 amends sections of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) to introduce a new way of handling termination payments, complete with new definitions and a formula to ensure the correct amount is taxed as earnings.

The aim of both the definitions and the formula is to identify an amount representing basic earnings during the notice period to ensure that it is subject to tax and national insurance contributions (NICs).

From 6 April 2018, the total amount of any termination payments made will be split into two elements. The first, the pay that is for the post-employment notice period, will be subject to tax and NICs, and the second, which is the remainder, will be taxable subject to the £30,000 exemption.

The new rules apply to all payments made, and benefits received, on or after 6 April 2018 where employment is terminated on or after 6 April 2018.

Below is an explanation of the new post-employment notice pay (PENP) formula and the new definitions, with possible implications that the changes may have on how termination packages are put together in future.

The formula

The first part of the PENP formula calculates the amount that represents pay for any minimum notice that has not been worked, now called the post-employment notice period. It is the period from the day after employment ended to the last day of the minimum notice, whether statutory or contractual (so it does not exist if the full amount of minimum notice is worked before the employment ends).

This part of the calculation is basic pay (BP) in the last pay period, divided by the duration of the last pay period (P) and multiplied by the duration of the post-employment notice period (D). It is written in the legislation as:

PENP formula

For example, an employee who is paid £3,600 per month has been told that the employment ends on 9 July, working notice to the end of the month. Using the formula above, pay representing the notice not worked is £1,080 (£3,600 ÷ 30 x 9). The post-employment notice period is 1 to 9 August.

The second part of the PENP formula is to deduct any taxable termination payment, T, which will include any pay in lieu of notice (PILON) made, whether the PILON is contractual or not. PENP is taxable and NICable in full, so this is how the legislation has removed the distinction between contractual and non-contractual PILONs.

The full PENP formula is:

PENP formula

The next step is to deduct PENP (if it is greater than zero) from the total termination package. Continuing the above example, the employee receives a total termination payment of £8,500. The PENP portion, £1,080, is subject to tax and NICs in full. The remainder, £7,420 (£8,500 - £1,080) is taxable but could be exempt using the £30,000 exemption threshold.

This all seems very simple and straightforward but, as is often the case, the devil is in the detail.

The definitions

While some of the definitions in the legislation are self-explanatory, others are less clear. And while some are terms that we are familiar with, others are totally new. For example, although basic pay (BP) is not a new term, it has a definition that is just for termination payments. Other definitions, such as the trigger date and the post-employment notice period, are introduced for the first time. A list of the definitions follows.

Basic pay (BP)

The legislation defines basic pay (BP) as ‘employment income of the employee from the employment’ and excludes various items including the following:

  • overtime, bonus, commission, gratuity or allowance
  • amounts received in connection with the termination of the employment
  • amounts that would be taxable as benefits or expenses
  • any amount that counts as employment income relating to securities and securities options
  • any amount that the employee has given up the right to receive but which would have otherwise been earnings.

This means, for example, that the value of salary sacrifice amounts must be included. Note that BP includes pay for holiday taken before the last day of employment, but does not include holiday pay for outstanding entitlement. It will include notional pay resulting from any salary sacrifice, but exclude optional remuneration payments and benefits.

As a result of the BP definition, it is not necessarily the case that the figures from the last pay run can be re-used. Basic pay may need to be recalculated

Total termination payments (T)

T is defined as ‘the total of the amounts of any payment or benefit received in connection with the termination that:

  • is taxable as earnings
  • is not pay for holiday entitlement taken before the employment ends, and
  • is not a bonus payable for termination of the employment.

The trigger date

The trigger date is defined as

  • the last day of the employment if no notice has been given or received, or
  • the day the notice is given.

The trigger date is not to be confused with the effective date of termination, which is usually, though not always, the last day that the employee works under the contract of employment. The effective date of termination could be moved and a payment in lieu of notice made, if appropriate, but the trigger date cannot be rearranged.

Post-employment notice period

This is the period from the day after employment ended, to the last day of the minimum notice, whether statutory or contractual.

If the employer gave notice of termination and the employee worked the contractual notice period (or took gardening leave) then the post-employment notice period would be zero. If however, the employer required the employee to leave without working the notice period, then there would be a post-employment notice period.


In many cases, the calculations will be simple and straightforward. However, it should be noted that there are a few pay elements where care needs to be taken, for example, to clarify:

  • whether outstanding holiday entitlement is to be taken before the termination date
  • whether any benefits being received are through a salary sacrifice arrangement

The new way of handling termination payments may prompt a rethink of how termination packages are put together in future, not only to ensure that the rules are adhered to, but also to make best use of the exemption.

HMRC’s guidance has yet to be published and there are complex areas of pay that will need further investigation.

One of the areas has however been clarified, thankfully. Because all PILONs are now treated as taxable and NICable earnings, we no longer have to grapple with their contractual status.

About Julie Hodgskin


Julie Hodgskin is technical material author at the Chartered Institute of Payroll Professionals.


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21st Feb 2018 09:11

In the above example P=30, being the notice period. Does this then calculate the pay based on a seven day working week. Should P not equal the number of working days in the notice period, rather than the total?

Thanks (0)
21st Feb 2018 11:15

The calculation if it is based on the month of July should surely be based on 31 not 3o days?

Thanks (0)
21st Feb 2018 14:16

Hi both,

Many thanks for your questions. I've heard back from the CIPP, here's what they had to say:

"...regarding ‘P’ in the calculation. As stated in the article ‘P’ is the last pay period before termination. In the example given termination was July, so the previous pay period was June (30 days).

"The second query is regarding calendar months or working days. The legislation talks of ‘days’, not ‘working days’, but it may be that it doesn’t stipulate so that employers can refer to their employment contracts and use that to calculate the termination payment. There should be more clarity on this in the guidance (when it is published)"

*Edit* That should read 30 days, not 30 months. Apologies.

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21st Feb 2018 15:15

Tom a little confusion by your reply, did you mean 30 days in the month of June not 30 months?

I may be in a minority but I find it difficult to agree with your comment, "This all seems very simple and straightforward..." If this is simple, I cannot wait for the details!

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21st Feb 2018 15:33

Apologies ewobrien,

In relaying the message from the CIPP days became months. You are, of course, correct, and I've amended the comment.

Thanks for flagging this up, best wishes,


Thanks (0)
By Vince54
23rd Feb 2018 15:44

Where the pay period is a month and the notice period is expressed in whole months, then "months" can be used instead of days. This may be a work around to the 'days' issue.

As long as there is consistency in what is used for "D" and "P" i.e. both use calendar days or working days,then there shouldn't be that much difference, should there?

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