On 24 July 2015, HMRC published a consultation document outlining proposed changes to the tax and NIC rules in respect of termination payments. The consultation is in response to the Office of Tax Simplification’s (OTS) final report on employee benefits and expenses which identified this complex area of the tax system fraught with confusion and uncertainty. The aim of the proposed reforms, which are quite broad, is to simplify the tax and NIC treatment and provide clarity for employers and certainty for employees on the amount of money they will receive when they lose their job.
The OTS found, not unsurprisingly, that there was a widespread but mistaken belief amongst employees and employers that the first £30,000 of any pay-off on termination was not subject to tax or NIC. Generally, the elements of the termination payment derived from employment, or that an employee is contractually entitled to, are subject to income tax and NIC in the same way as salary. Conversely, payments not linked to employment, including some non-contractual payments, are liable to tax on amounts exceeding £30,000 under ITEPA 2003, s 401, but free from NIC. Much of the confusion arises from the lack of understanding by employers about the differences between contractual and non-contractual payments, especially when dealing with payments in lieu of notice (PILONs). There are also specific exemptions which add to the complexity.
Proposals under consultation
The OTS made a number of suggestions to simplify this area of tax and the government, recognising the difficulties with the taxation of termination payments wish to reform the treatment so as to make the process more easy to follow and generally fairer whilst being affordable to the Exchequer. They have therefore proposed the following changes:
- Removing the distinction between the tax and NIC treatment of contractual and non-contractual termination payments;
- Alignment of tax and NIC treatment meaning that both employers and employee NIC charges could arise on future termination payments in addition to the tax;
- Exemption for those who have completed two years of service and have been made redundant as defined in Employment Rights Act 1996, including those accepting voluntary redundancy. The level of exemption would increase at a set rate with each year of service completed up to a maximum;
- Anti-avoidance targeting arrangements aimed at sacrificing salary in exchange for tax exempt termination payments;
- Retaining the exemptions for injury or disability and HM Forces but removing the foreign service exemption; affecting those who have spent a great deal of their working life abroad.
- Introducing an exemption for payments in connection with wrongful or unfair dismissal or compensation paid in connection with discrimination.
Although the proposals are subject to consultation, these are significant changes which if enacted, will generally mean that all payments made in connection with termination would, as a starting point, be treated as earnings subject to tax and NIC. The new exemption would only apply to a genuine case of redundancy and only after two years of service have been completed so the scope of this may be limited although there appears to be extra protection for those unfairly or wrongfully dismissed. If the maximum exemption is set at £30,000, with the proposed alignment of tax and NIC does this mean that both tax and NIC will be charged on payments exceeding this figure? The removal of the foreign service exemption will also adversely affect those who have been working on long term contracts abroad.
A copy of the full text can be found by clicking here.
Responses to the consultation can be made up to 16 October and the government will publish details of the responses and make announcements on this further in the Autumn Statement 2015. For those practitioners who may be dealing with possible termination cases in the future should review the proposals and be aware that changes may be afoot.
If you would like further information in relation to the taxation of termination payments please contact the TaxDesk on 0845 4900 509 and ask for Martin Mann.