Taxation of Termination Payments - Is it time to replace the £30k tax exemption, as the OTS suggests?

The Office for Tax Simplification (“OTS”) has recommended that the current £30,000 tax exemption for termination payments should be scrapped and replaced with a new income tax relief available only to employees who qualify for a statutory redundancy payment. 

The proposal states all payments made to such an employee would qualify for income tax relief, irrespective of the nature of the payment and whether it derives from the employment contract. Simplicity and certainty are the advantages put forward, making it easier for employers to administer and for employees to know the value of what they are receiving. There should also be no risk of an unexpected tax bill.

Employers would no longer have to identify each element of a redundancy package separately and work out its tax treatment. For example, all notice monies would qualify for income tax relief, whether there is a payment in lieu of notice clause in the employment contract or not. Tricky assessments of whether the payment amounts to an auto-PILON would no longer have to be made. 

Whether this really is a win-win situation for employees who are made redundant will of course depend on the tax relief limit. To the extent that the payment exceeds this amount it will be subject to income tax. Two options are put forward, the preferred one being a multiple of the employee’s statutory redundancy payment, with the alternative being a flat amount. No indication is given of the multiplier that could be used or the flat amount, although a worked example uses a multiplier of three. Employees with shorter service, whose statutory redundancy payment could be as low as £928, may find that the amount of tax relief does not even cover their notice pay. Employees with less than two years’ service do not qualify for a statutory redundancy payment and so would not qualify for tax relief. 

If the OTS’s proposals are adopted, termination payments made to employees in cases other than redundancy would be taxed in full. Employers will be concerned that this may increase their employee termination costs. Employees concerned at the loss of a valuable tax exemption will seek to negotiate higher termination payments. Employers may have to offer more to achieve a settlement or be faced with fighting unfair dismissal claims. Employee shareholders, who have no right to a statutory redundancy payment under waiver arrangements, would have their termination payments taxed in full. 

No doubt HMRC will be alive to attempts by employers and employees to avoid tax by describing the reason for dismissal as redundancy. Employees only qualify for a statutory redundancy payment if the business they work in or their workplace closes, or if fewer employees are needed to do the work. This is not always a straightforward assessment and parties can expect HMRC to scrutinise borderline cases carefully. Then again, the relief available may not be that great.

The proposals will require a policy decision from the Government which may not be made until after the election next year. 

Peter Doyle is senior partner at employment law specialists Doyle Clayton.

This article, written by Peter Doyle, was originally published in Tax Journal at http://www.taxjournal.com/tj/ln-search?search_api_views_fulltext=Peter%20Doyle&sort_by=search_api_relevance&sort_order=DESC