Future of £30,000 Tax Exemption for Termination Payments in Doubt

The Office for Tax Simplification (“OTS”) has proposed 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 new system would have the advantage of simplicity. The proposal is that all payments made on termination of employment to an employee who qualifies for a statutory redundancy payment should qualify for income tax relief, irrespective of the nature of the payment and whether it derives from the employment contract. This would mean, for example, that contractual payments in lieu of notice and payments for post termination restrictions (both of which are currently subject to income tax) would be covered by the relief and not be taxable. The amount of the income tax exemption would be either a multiple of the employee’s statutory redundancy payment or, alternatively, a flat amount. No indication is given of the multiplier that should be used. 

If the OTS’s proposals are adopted, it would mean that payments made to employees in cases other than statutory redundancy would not qualify for relief and would be taxed in full. 

The OTS considered the option of extending the proposed relief to all payments made where employment is terminated for any reason and recognised that this is something which might be the subject of further consultation. It recognised that there is an argument that payments made pursuant to a statutory right, such as for unfair dismissal, should be tax exempt although this would add an additional layer of complexity. 

The OTS also recommended:

• a formal consultation to review other exemptions available in respect of payments made on termination, such as the injury and disability exemption and the exemption for legal costs and outplacement counselling; and
• a review of whether the income tax and National Insurance Contributions treatment of termination payments should be aligned. 

The Government’s response to the OTS’s recommendations will be awaited with interest and may be contained in the Chancellor’s Autumn Statement. 

The OTS’s recommendations are designed to simplify the tax treatment of termination payments and they certainly appear to achieve this. In statutory redundancy cases, employers would no longer need to look at each element of a termination payment and decide if it is taxable or whether it falls within the £30,000 exemption (or any other exemption). In other cases, employers will know that they have to tax the whole payment. 

However, employers will be concerned that the proposals may increase their termination costs - having to tax payments except in statutory redundancy cases may mean that they have to offer more to achieve a settlement or face having to fight unfair dismissal claims in the employment tribunal. 

Employees will also be concerned at the loss of a valuable tax exemption where they are not being dismissed for redundancy. No doubt HMRC will be alive to attempts by employers and employees to avoid tax by describing the reason for dismissal as redundancy. Parties can expect HMRC to scrutinise borderline cases carefully to identify whether the reason for dismissal falls within the statutory definition of redundancy.