TERMINATION PAYMENTS AND TAX
Here we consider how specific kinds of termination payment are treated for tax purposes in the light of the statutory framework and relevant case law. All references below, unless otherwise stated are to the Income Tax (Earnings & Pensions) Act 2003 (ITEPA).
Statutory Redundancy Payments made under the Employment Rights Act 1996 (ERA) are specifically exempted from general earnings under section 62 of the ITEPA by S.309. However, such payments fall within S.401 and are chargeable to tax under that section, subject to the ?30,000 exemption. The maximum statutory redundancy payment is well below the ?30,000 exemption from which it follow that, unless the value of other taxable elements of a termination package cause the ?30,000 limit to be exceeded, statutory redundancy payments will usually be exempted in full under S.403.
Similarly, a payment under a contractual redundancy scheme will usually be tax-free so long as it is less that ?30,000. This is the result of the House of Lord’s decision in Mairs v. Haughey 1993 66 TC 273 that such a payment is not as an emolument since it is not paid for service rendered by rather as a means of compensating and employee for not being able to continue to earn a living from the former employment. The upshot is that contractual redundancy payments are only taxable under S.401 and as such attract the so-called “golden-handshake” exemption.
The same is true of redundancy payments paid out under a non-statutory scheme or arrangement. Certain schemes provide payments to categories of employee not covered by the statutory redundancy provisions in the ERA. NHS employees employed under the General Whitley Council conditions of service are one example. The Revenue’s policy is to treat payments made on account of genuine redundancies and paid out under such schemes or arrangements as being akin to contractually enhanced redundancy payments.
Ensuring accuracy in the labelling of redundancy payments is crucial if the employee is to avoid a demand for tax on a termination payment that was thought to attract the golden handshake exemption. One way to avoid mistakes is for employers to utilise a procedure whereby they can obtain “clearance” for lump-sum payments under contractual or non-statutory redundancy schemes from their local tax office. Such clearance ensures that redundancy payments will be accepted as being liable to tax only under S.401.
PAYMENTS IN LIEU OF NOTICE
The phrase “payment in lieu of notice” (PILON) is used to describe a range of payments made in a variety of situations where the employee’s contract of employment is terminated and he or she is compensated for the relevant period of notice. In considering the taxation of such payments, it is important to be clear on the circumstances in which they are made.
Contractual PILONS. Where an employee receives a contractual PILON -i.e. where the contract expressly provides that employment may be terminated by the making of a PILON instead of actual notice – the payment is chargeable to tax under S.62 as earnings from the employment.
Similar reasoning applies to any payment received by an employee placed on “garden leave”. In this situation the employee will typically be given proper notice of termination of employment in accordance with the terms of the employment contract but told not to attend work during the notice period.
It is therefore subject to the same taxation as normal salary payments.
One situation in which a PILON will not be regarded as earnings from employment but as compensation for loss of office is where there is no provision for PILON in the contract. Where the employer unilaterally dismisses the employee with less , he has breached the contract of employment and the PILON will be regarded as damages. Such damages when paid on the termination of employment comprise compensation for loss of office and therefore fall within S.401, with the consequence that the ?30,000 general exemption applies.
AGREEMENTS TO TERMINATE
Even in the absence of a contractual right to terminate by giving a PILON, the employer and employee may reach an agreement to terminate on such a payment. So long as this is done only as part of the process of termination, the payment will not be regarded as deriving “from ” the employment but from the agreed terms for its termination and so will be regarded as a damages payment. In those circumstances the payment will fall within S.401 even though no breach of contract has occurred.
When an employment terminates, employers often seek to avoid potential claims by the employee, such as unpaid salary, unfair dismissal or unlawful discrimination. Often these claims are settled out of court by the employer and the employee reaching a compromise agreement. The effect of a compromise agreement is to ensure that the employee concerned cannot pursue his or her claims through the civil courts or Employment Tribunals.
As the compromise agreement is separate from the employment contract and deals only with the termination of employment, it only gives rise to payments and benefits within S. 401.
Nevertheless, there may well be elements included in the compromise agreement that are chargeable under other tax sections. Accordingly, it is necessary to consider whether any contractual entitlements have crystallised in order to see whether there are any charges under sections other that S.401, such as a contractual payment in lieu of notice.
Repayment clauses. The Inland Revenue has confirmed that the existence of a repayment clause in a compromise agreement will not normally mean that payments made under the agreement are susceptible to tax. Such clauses require the employee to repay some or all of the agreed payment if he or she subsequently litigates in respect of the employment.
An employee may incur legal costs in pursuing litigation to recover compensation for loss of office. Such legal action may comprise, for example, a county court claim for wrongful dismissal or an employment tribunal claim for unfair dismissal. Extra-statutory concession A81 provides that payments of legal costs to an office-holder or employee will receive special treatment in the following circumstances:
where the legal dispute is settled without recourse to the court/tribunal, no charge will be imposed
under S.401 on a payment made by the employer directly to the employee’s solicitor so long as (i) the payment
is made pursuant to a specific term in a settlement agreement, and (ii) the payment is in full or partial discharge
of the solicitor’s costs incurred solely in connection with the termination of the employee’s employment.
where the dispute proceeds to a court or tribunal, no charge will be imposed on a payment of costs made by
the employer, even if this is paid directly to the employee, so long as the payment is made in accordance with a
court or tribunal order.
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