HMRC win case in respect of contractual payment in lieu of notice

HMRC win case on payment of contractual PILON

In the recent case of Peter Andrew v HMRC [2015] TC04672 the First-tier tribunal accepted HMRC’S argument dismissing an appeal against an assessment raised on a termination payment made by Mr Andrew’s previous employer. Although the tribunal accepted that Mr Andrew was made redundant the payment made under a compromise agreement was in made in accordance with his employment contract and therefore taxable as earnings.

The facts of the case

Mr Andrew became an employee on 1 April 2011 after two years of consultancy work but was dismissed from his job unexpectedly and without notice the following month. His employer gave him a Compromise Agreement in order to derive a full and final settlement over claims he may have arising from his contract of employment or its termination and to avoid claims for unfair/ wrongful dismissal. Under the agreement Mr Andrew was paid £68,000 which he analysed as follows:

  • £54,000 salary (six months pro-rata of annual £108,000 salary)
  • £4,800 car allowance (6 months allowance at £800 per month)
  • £10,800 pension contribution (20% of salary)

Mr Andrew did have a contract of employment which outlined a basic entitlement to six months’ notice but provided an option for his employer to make a payment to Mr Andrew instead of giving him notice in other words a payment in lieu of notice (PILON).

His employer took the view that the whole payment was subject to PAYE and due to financial pressure, Mr Andrew signed the Compromise Agreement on that basis. He contended however that his employment contract was terminated by redundancy and that pursuant to the Compromise Agreement, the first £30,000 would be exempt by virtue of s403 ITEPA 2003. He made a subsequent claim via his self-assessment tax return leading to an overpayment of tax. HMRC argued that if Mr Andrew had been made redundant that this does not mean that the termination payment automatically falls within s401 ITEPA 2003 and that the first £30,000 payment is exempt. Their view was that the payment constituted a PILON under the terms of employment contract itself flowing from the employment relationship and therefore taxable as earnings under s62 ITEPA 2003. The self-assessment return was amended turning an overpayment into an underpayment.

Decision

The important point was the nature of the payment made. The tribunal sited the case of EMI Group Electronics Ltd v Coldicott [1999] involving a similar PILON, where the High Court, affirmed by the Court of Appeal, stated that the PILON was taxable as earnings even though, as in this case the PILON was payable at the discretion of the company. In line with the decision in that case, the tribunal concluded that the basic salary and other benefits paid under the Compromise Agreement were intended to constitute the “payment” which the company was entitled to make in lieu of notice under the employment contract and that the whole termination payment was taxable.

The decision in this case is not surprising given the general understanding that any termination payment derived from a contractual obligation would be exposed to income tax and NIC as general earnings. The taxation of termination payments was subject to consultation which ended on 16 October 2015. Part of the proposals put forward by the Office of Tax Simplification (OTS), is to remove the distinction between contractual and non-contractual termination payments and to provide relief for those with at least two years’ service who had been made redundant. Given the fact that the tribunal had accepted that Mr Andrew had been made redundant it is interesting to ponder on whether the outcome may had been more positive for Mr Andrew under these new proposals although the short time in which he was in employment would likely go against him.

If you would like further information on this case or on termination payments, please contact the TaxDesk on 0845 4900 509 and ask for Martin Mann.