NIM02510 | Class 1 NICs: Earnings of employees and office holders: Payments made on termination of employment: Before 6 April 2018

From HM Revenue & Customs · National Insurance Manual

NIC liability on payments made on termination of employment, particularly payments in lieu of notice (PILONs) and payments in lieu of remuneration (PILORs) and redundancy payments, has for some time been a source of difficulty. The main problem arises in trying to decide whether such payments are:

essentially compensatory in nature. In that event there would be no liability for NICs, or
really payments of earnings on which NICs are due.

A compensation payment usually relates to the recompense offered and accepted in relation to the cancellation of a contract. It must be distinguished from a payment given under the terms of a contract.

For example, a compensation payment may take the form of a sum awarded as damages by a court where an employer breaches the terms of a contract of employment, possibly by not giving the required period of notice of termination of the employment. Alternatively, it may be a sum negotiated to prevent court action.

Compensation payments can also be described as ‘ex gratia’ payments or ‘golden handshakes’. If so, consider the agreement reached between the employer and employee to see whether or not it falls within the description of a compensation payment outlined above.

You should remember that it is important always to establish the exact nature of a payment by determining the reason for its being made. You should not be misled by how the employer titles the payment and you must always look at the facts surrounding the making of the payment rather than relying on what the employer calls it.