When an employer makes a payment to an employee on termination of employment, in broad terms, the current tax position is that if the payment is not contractual (or otherwise “derived from employment” and taxable under prevailing law), then up to £30,000 is tax and NIC free. Any balance above £30,000 is subject to tax but not NICs. Further tax free exemptions are possible, e.g. where termination is as a result of death, injury or disability or where a termination payment is made into a registered or tax exempt pension scheme.
The current rules create difficulties for employers if they:
(i) Do not properly analyse when making a termination payment, what the payment is in fact comprised of; i.e. is it purely ex gratia or is it comprised of any contractual elements or taxable earnings?
(ii) Attempt to label a payment as “ex gratia” termination payments when it is earnings.
(iii) Do not have an express contractual clause authorising payments in lieu of notice, but habitually make such payments, meaning the payment in lieu of notice is taxable.
The HMRC’s first port of call for unpaid tax on a termination payment (plus interest and penalties) is the employer, not the employee.
On 24 July 2015, HMRC published a consultation document setting out proposals to simplify the tax and NICs treatment of termination payments. The proposals for simplification include the following:
1. Classifying all payments on termination as earnings, making them subject to income tax, employer NICs and employee NICs, including payments in lieu of notice, whether they are contractual or not.
2. Making the tax and NICs treatment of a termination payment the same.
3. Creating a new exemption which increases proportionately with the number of years of service the employee has completed.
4. Requiring a qualifying period of service before an employee was able to benefit from a tax free payment on termination.
5. The government is considering only providing tax and NICs relief where the termination payment has been made in connection with a redundancy, i.e. where the termination of the employment is wholly or mainly attributable to: (i) the employer ceasing, or intending to cease, to carry on the business for the purposes of which the employee was employed; (ii) the employer ceasing or intending to cease to carry on that business in the place the employee was employed; (iii) the requirement for the employee to carry out work of a particular kind of work has ceased or diminished or is expected to cease or diminish; or (iv) the requirement to carry out work of that particular kind in the place where that employee was employed has ceased or diminished or is expected to cease or diminish.
6. New exemptions in respect of (i) compensation for unfair or wrongful dismissal; and (ii) compensation for loss of future earnings following discrimination.
7. Retention of exemptions in respect of termination payments resulting from injury or disability. It is unclear what is proposed in relation to the current exemption for termination payments resulting from the death of the employee.
8. Exempt payments would come back into the charge to tax if the employee were re-engaged to perform the same, or a similar, job for the same, or an associated, employer within 12 months of the termination.
The government is expected to publish a summary of responses and an announcement on any decisions made in respect of the simplification proposals in early 2016.
For further information on the issues raised in this article, please contact us on 020 7925 8080 or by email at firstname.lastname@example.org