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Making tax on termination less tricky

Employers and employees alike will welcome the government’s recent consultation on simplifying the tax treatment of termination payments. The current system causes confusion and uncertainty for both parties at an already stressful time and is due to be reformed pending the outcome of the consultation.

So, what is the government proposing and how may this affect you?  

After reading our report below, we would encourage you to submit your comments on the proposals to us, which we will collate and send to HMRC.

The current system

Employers and employees will be familiar with the current £30,000 tax-free allowance for payments or other benefits which are made in connection with the termination of employment. Any payments falling within the criteria for the £30,000 allowance but which exceed it are liable to income tax, but not employer or employee national insurance contributions (NICs). Conversely, any elements of a termination payment that are contractual or are otherwise connected to employment are subject to both income tax and NICs.

All of this leads to confusion and uncertainty, with parties having to look at the various elements that make up a termination payment to determine the correct amount of tax and NICs to deduct. 

Proposals for reform

The government’s aim is to introduce a new system that is simple for employers and employees to understand, will be easy to administer and will provide certainty about how much tax and NICs must be deducted. The government is also aiming to level the playing field so that those “who are better paid and better advised… do not receive a more favourable tax and NICs treatment than those who are lower paid”. In order to achieve these aims, the government is considering the following headline proposals for reform:

Removing the distinction between the tax and NICs treatment of contractual and non-contractual payments (including Pay In Lieu of Notice (PILON) clauses). Instead, all payments made in connection with termination of employment will be classed as 'earnings' and will therefore be subject to both income tax and employer and employee NICs, unless they fall within one of the new exemptions set out below. To further add simplicity, the government also plans to align the income tax and NICs treatment of termination payments.

Removing the existing £30,000 allowance and introducing new exemptions in its place. These would apply on termination of employment so that payments falling within the exemptions would not be subject to income tax or NICs:

  • An exemption available only to employees with at least two years service. The suggestion is for the exemption to increase at a set rate with each year of service up to a maximum cap. The government is considering limiting this exemption to employees being made redundant (either compulsorily or voluntarily).  
  • Creating new exemptions for payments made in connection with compensation for wrongful or unfair dismissal and discrimination. 

The above is only a summary of the main changes proposed. For full details please refer to the consultation document.

The government is keen to hear views from anyone who is affected by the proposals. These responses will help form the government’s plan for reform, which will be announced as part of the Autumn Statement 2015. 

If your business would like its views to be heard please send your comments to us via our Professional Support Lawyer, Amy Whiting at amy.whiting@TLTsolicitors.com. We will collate all responses we receive and send them to HMRC. Responses are invited by 16 October 2015 so please ensure that your comments are with us by 14 October 2015.

Impact

The consultation is welcome news, with the reasoning behind the government's proposals encouraging. The aim to create a system which is certain, understandable, fair and affordable is clearly in the best interests of employees and employers alike. However, much of the detail is yet to be determined. 

Under the proposals, employees with less than two years' service would not be able to benefit from the exemption, potentially raising indirect discrimination issues. 

If the exemption only applies to redundancy situations then there will be more pressure on employers to make staff redundant in order to qualify for the tax exemption. It remains to be seen whether the additional proposed exemptions for unfair dismissal and discrimination payments will adequately address this concern.  

Whilst aiding simplification, the proposal to align the income tax and NICs rules may negatively impact employers by leading to increased employer NICs costs than are payable under the existing regime.  

The current call for feedback is a welcome opportunity to input into the future system; but we will need to wait a little longer for the final detail. 

Do not hesitate to contact us if you have any queries or if you would like us to submit a response on your behalf.  

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at September 2015. Specific advice should be sought for specific cases. For more information see our terms & conditions on www.TLTsolicitors.com

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