Taxation of termination payments – changes to come

In July we outlined the Government’s intention to enter into a period of consultation on proposals to simplify and make changes to the way payments made to employees on the termination of their employment are taxed. You can read that article here. That period of consultation has now ended, and perhaps not surprisingly, the proposals have not been viewed favourably by employers.

One of the main parts of the proposal was to do away with the distinction in tax treatment of contractual and non-contractual termination payments. In other words, the present position where the tax treatment of a payment in lieu of notice is determined by the inclusion or otherwise of a payment in lieu of notice clause in a person’s contract of employment would go. This must make sense, as in more cases than not it is simply a matter of luck whether the employee is entitled to receive a payment in lieu of notice tax free, or whether they have to pay tax on it.

The area which has caused most concern amongst employers is the removal of the £30,000 potential tax exemption and to replace it with a much reduced figure which would be based on length of service, and would only apply to redundancies and Tribunal awards. Employers often use some of the tax free allowance to effectively pay off employees rather than face Tribunal claims. From an employee’s perspective it is of course much more attractive to settle a potential dispute by receiving a payment, and if it can be paid without deduction a lower payment is going to be just as attractive as a higher payment which has to be taxed – in other words, it is the actual amount which the employee receives which is what matters.

Concern has also been expressed about tax free termination payments only being available in redundancy situations and where Tribunal awards are made. Redundancy is of course not the only type of no fault dismissal, with some business reorganisations not necessarily amounting to redundancy, plus of course ill health terminations would also not be eligible for tax free payments. Perhaps of more concern is the proposal that in other situations the employee would have to go to Tribunal and get an award in order to enjoy the tax free exemption, rather than be able to do a deal before going to Tribunal. This seems to fly in the face of the various changes to the law the Government has made to reduce Tribunal claims.

What does appear to be clear is that for many employees the amount of any tax free allowance will be significantly reduced from the current £30,000. It also seems that the proposed changes will not simplify the existing rules, but rather shift the complexity from examining the nature of a payment in lieu of notice to having to examine the reason for the termination.

We will have to wait and see what changes the Government makes as a result of the consultation and we will of course update you on these when they are available.

If you need advice on any aspect of employment law, please contact any member of the Pure Employment Law team (01243 836840 or [email protected]).

Please note that this update is not intended to be exhaustive or be a substitute for legal advice. The application of the law in this area will often depend upon the specific facts and you are advised to seek specific advice on any given scenario.