Draft legislation published ahead of next month’s Budget shows that what are known as Payments in Lieu of Notice (PILON) will no longer be exempted from tax up to £30,000 after April 2018.

At present, redundancy payments are made up of a number elements including compensation for losing your job and PILON. Up to now, the first £30,000 of the PILON element has been exempted from income tax where the payment was not a contractual right.

Changes proposed in the draft legislation will remove the exemption for all PILON payments apart from where they relate to bonuses that the employee would have received if they had kept their job. Employers will also have to pay National Insurance contributions on PILON amounts over £30,000 for the first time.

Mark Cawthron, a tax expert at Wolters Kluwer said: ‘This reform to the taxation of termination payments will actually have a pretty fundamental and widespread impact.

‘In particular, in most terminations, it will very largely cut away the financial benefits and in the case of larger termination packages, for senior executives or other high earning staff, the new National Insurance liability will be a significant extra cost for employers.’

The exemption for bonuses PILON will give people whose bonuses make up a large part of their pay an advantage over workers who just earn a basic salary.

Cawthron said: ‘Arguably rather perversely, therefore, the likely beneficiaries here are those senior staff or executives who work for larger, particularly listed, companies, or staff who work in the financial services sector where bonuses can make up a significant portion of pay. Indeed, one possible reaction to the government’s reform is that it does not operate particularly fairly with respect to less well-paid employees.’

Stuart Chamberlain, Wolters Kluwer’s UK employment law expert said: ‘The difference between a non-contractual tax-free PILON, where the employee was entitled to a £30,000 exemption, and a contractual PILON, which attracted tax and NICs, was long thought to be unfair. Employers should start preparing for these changes now, particularly if they are envisaging reorganizations or re-structuring that could involve termination by PILONs and redundancy.’

The government had originally planned to tax bonus payments as well as basic PILON but reversed the plan after consultation. The changes will be included in the Finance Bill which will be published after the Budget on March 8 and, if approved by Parliament, will come into effect in April next year.