On 24 July 2015, Her Majesty’s Revenue and Customs launched a consultation on the tax treatment of termination payments called “Simplification of the tax and national insurance treatment of termination payments”.
Room for improvement
Exit payments associated with employment contracts are taxable and subject to national insurance contributions (NICs). The difficulty for employers and employees is that when an employee loses their job, their payment can be made of various elements, some of which may be taxable and some not. The government is concerned that the complexity of the system means:
- Employees have little certainty on what amount of money they will receive if they lose their job; and
- Employers have to assess each element of termination payments to see which are contractual and which are not, to work out which should have tax and NICs deducted.
The government wants to make taxation of termination payments simpler for companies to administer and outcomes fairer for employees, in particular those in long serving jobs at lower levels of pay.
The government expects to publish its decision in Autumn 2015 and any changes may happen fairly swiftly after this.
The proposals
The government’s proposals in outline are to:
- Remove the distinction between contractual and non-contractual termination payments, and the same for payments in lieu of notice;
- Remove the £30,000 tax-free allowance for non-contractual termination payments and introduce a new tax free allowance for redundancy (including voluntary redundancy) payments to employees who served more than two years, with the amount increasing by each year of service to a maximum cap; and
- Remove tax exemptions relating to foreign service and legal costs, retaining those for injury/disability and HM Forces.
“Compensatory” payments for discrimination or wrongful/unfair dismissal
- The government is looking to make all “compensatory” payments (for, for example, wrongful/unfair dismissal or discrimination) free of tax and NICs;
- It is proposed that the tax exemption would only apply up to a financial cap and that the caps for discrimination and unfair/wrongful dismissal may differ;
- The government may set different caps depending on whether the employer and employee negotiate the payment or a Tribunal gets involved.
Overall position
Although the current tax rules are not altogether straightforward (and on an exit there is often uncertainty about whether any payment of £30,000 will remain tax free after being considered by HMRC), the current rules do seem simpler than what is being proposed.
Implications could be:
- More accountant involvement in exit negotiations;
- More delay in exits being concluded as the tax situation is resolved;
- Closer consideration of the facts leading up to the exit to determine whether the payment is truly a contractual payment or compensation for a legal case;
- Less ability to structure settlements in a tax efficient manner;
- More or less tax being payable depending on the circumstances leading to the exit and whether or not the ultimate level of the proposed caps is lower or higher than the current £30,000 tax free threshold. This has not yet been decided;
- Less tax to pay if disputes are resolved in-house rather than through court processes.
For those businesses that commonly use settlement agreements to assist exits of staff, it will be very important to understand these new rules if and when they come in, as it may well impact on how you approach settlement, what sums are offered and how this is recorded.
Watch this space!