On the termination of an employee’s contract it is possible that the first £30,000 of any termination payment may be paid tax free. However, this exemption is not mandatory and there are a number of conditions which must be met before it applies.
Broadly these conditions are met where the termination payment is compensation, e.g. for discrimination or wrongful termination, or more commonly for a breach of the employment contract.
The exemption does not however apply where the payment or benefit is:
- earnings (such as contractual payments, bonuses, holiday pay etc.);
- for a restrictive covenant; or
- a pension
There are, however, certain termination payments which may qualify for a higher limit, or may be paid tax free, where the payment relates to injury, disability or death. Payments relating to an employment which included an element of foreign service may also be wholly or partly exempt, depending on the extent of that overseas work.
In looking at the termination payment there is a requirement to also include the cash equivalent of any non-cash benefits made, for example the provision of a company car. Any non- cash benefits are treated as income in the year in which the benefits are enjoyed.
Where the exemption is available then currently no National Insurance (NI) will be due. For example, if a qualifying termination payment of £100,000 is made, £70,000 will be taxable, but there would be no NI.
However, from April 2018 termination payments over £30,000, which are subject to income tax, will also be subject to employer NICs. In the above example, the £70,000 not covered by the exemption will also be subject to employers NI where the payment is made after 5 April 2018.
Where a qualifying termination payment is made to the employee before they leave, the excess over £30,000 is subject to deduction of tax under PAYE under the normal rules. If payments are made to employee after they leave, and after form P45 has been issued, then the employer must deduct tax under PAYE at the basic rate. The employee would then be liable for any additional tax charge on the termination payment received under the self-assessment system.
Opportunities
There are a few planning opportunities where the termination is to exceed the £30,000, such as:
- consider making a contribution towards the employees’ legal fees, which may include, for example the employees’ solicitors fees in reviewing a compromise agreement.
- deferring the tax point – there may be a tax saving to the employee by spreading the payment over 2 tax years. The entitlement to deferred consideration should be specified in the settlement agreement.
- consider making a contribution into the employees’ pension fund.
- consider whether any element of the payment made could be identified as compensation for discrimination, or injury/disability which may be tax free.
Given the complex nature of the legislation we would suggest that advice is sought before any termination payment is made, to avoid any potential bear traps. Failure to take reasonable care in analysing the nature of the payment and describing it in the settlement agreement may result in the parties facing unnecessary or unexpected tax liabilities.
If you are about to make a termination or redundancy payment, or if you have recently received a payment and believe you may be entitled to a tax refund please do not hesitate to contact me or a member of our tax team.