From 6 April 2018 all payments in lieu of notice (PILON) will be treated as earnings and subject to tax and class 1 NICs.
Until now, whether a PILON was subject to tax depended on whether the employee had a contractual right to be paid in lieu of notice. From 6 April 2018, the tax treatment will no longer depend on the category of PILON or its contractual status. Instead tax will be charged on the basic pay the employee would have received if he or she had worked his or her notice. When notice is not worked, you must now treat a part of the termination payment (excluding statutory redundancy pay and approved contractual pay) as an amount to reflect the basic pay for the notice period, and you must tax it.
There is a formula set out in the relevant tax legislation (Income Tax (Earnings and Pensions) Act 2003) to guide you. Basic pay is employment income, not including overtime, bonuses, commissions etc.
HMRC guidance will assist with the calculations and provide you with more information on the trickier areas, such as how to deal with contributions to pension schemes on termination. Your payroll teams should take tax advice on the relevant changes and ensure their payroll systems are updated before 6 April.