Termination payments

HMRC recently published their response to the consultation document entitled ‘Simplification Of The Tax And National Insurance Treatment Of Termination Payments’. This document arose out of a review by the Office of Tax Simplification (OTS) which highlighted the complications of the current termination payment system with the consequential likelihood of mistakes being made by the various parties involved.

The consultation document contained a number of proposals for amending the income tax and NIC treatment of termination payments.

Following feedback received, the Government have decided to:

  • retain the £30,000 income tax exemption;
  • continue with an unlimited employee NIC exemption;
  • make all payments in lieu of notice subject to income tax and NICs as earnings, regardless of whether they are contractual or not;
  • treat any other contractual payment (including amounts which employees would have received had they worked their notice period) as earnings subject to income tax and NICs;
  • align the rules for income tax and NICs so that employer NICs will be due on termination payments in excess of £30,000;
  • remove the foreign service relief (which wholly or partly exempts non contractual payments from income tax where the employee has worked abroad for a significant part of his period of service); and
  • make it clear that the exemption for injury payments does not extend to payments for injured feelings.

These changes take effect from 6 April 2018. The relevant legislation was set out in Cl 15 FB 2017. Although removed from the final Bill that was enacted ahead of the June general election, it seems almost certain that, whoever wins the election, these changes will go through in a second Finance Bill later in the year
Expanding on some of the points above, it should be noted that FB 2017 split an employee’s termination payment into two categories:

1. payments which can still benefit from the £30,000 threshold;
2. payments which cannot.

The employer has to identify the amount of basic pay which the employee would have received had he worked his notice period.

This is the case even if the employee leaves his employment part way through the notice period. The resulting sum will be treated as earnings and will not be subject to the £30,000 exemption. Basic pay for this purpose excludes any overtime payment, bonus, commission and gratuities.

All employees will be required to pay tax and Class 1 NICs on the amount of basic pay which they would have received if they had worked their notice period in full. This means that the income tax and NIC consequences will no longer depend on how the employment contract is drafted or on whether payments are structured to represent some other form of arrangement (eg. a payment for damages).

One’s initial feelings about these provisions are:

1. annoyance that these amendments are likely to complicate the law rather than simplify it (which is what the OTS wanted);
2. regret that non-contractual payments in lieu of notice, which presently fall within the £30,000 exemption, will cease to do so;
3. surprise that the intention to impose employer NICs on termination payments in excess of the statutory limit will raise revenue for the Exchequer without there being any compensating adjustment to the – unaltered since 1988 – £30,000 threshold (the OTS suggested that any changes to the treatment of termination payments should be revenue-neutral);
4. concern that the introduction of NICs on termination payments over £30,000 will cause confusion among employers as regards when, and to what extent, such payments are chargeable or exempt; and
5. unease that the imposition of NICs on termination payments may make employers more inclined to reduce termination packages in order to compensate for the additional employment costs.

Finally, it should be noted that, although professional bodies such as the CIOT called upon the Government to rethink their plan to abolish the foreign service relief which has worked well over many years to provide an exemption where all or part of an employee’s duties were performed abroad, the withdrawal of the relief is still going ahead.