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Taxation of termination payments

Published Tuesday, October 3, 2017

In the 2017 Budget the Government confirmed that it would introduce legislation to amend the tax treatment of termination payments. Provision to this effect is included in the Finance Bill 2017-19 (specifically clause 5 of the Bill). This note discusses the background to this reform.

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‘Qualifying termination payments’ that an employee receives on redundancy may be free of income tax, up to a limit of £30,000. This applies to statutory redundancy pay – the legal minimum which an employer is obliged to pay an employee – and any ex-gratia payments made by an employer to compensate for loss of employment by reason of redundancy. Only the excess over £30,000 is charged income tax, although a payment that qualifies for the £30,000 exemption is free of National Insurance contributions (NICs), whatever its amount.  By itself, statutory redundancy pay is unlikely to exceed £30,000, but it must be included with any other qualifying payments when applying this threshold. 

Certain types of termination payment are exempt from income tax – for example, a payment made on the death, disability or injury of an employee. However, at the time of someone being made redundant, it is likely they will also receive payments which are part of their contractual employment pay, and taxed as such: for example, holiday pay, bonuses, arrears of pay or a ‘payment in lieu of notice’ (PILON).

Over 2013-14 the Office for Tax Simplification (OTS) undertook an inquiry on the tax treatment of employee benefits and expenses. In its final report the OTS recommended certain reforms to the tax regime for termination payments, as “this is an area which gives rise to confusion because many people believe that the first £30,000 of any ‘payoff’ will be tax-free” and “many employers are unclear about which parts of a termination package qualify for the exemption.”[1] In turn HM Revenue & Customs consulted over summer 2015 on proposals to simplify the rules, but also to prevent their manipulation for tax avoidance purposes.

The 2016 Budget confirmed the Government would proceed with this reform, while emphasising that “the first £30,000 of a termination payment will remain exempt from income tax and the full payment will be outside the scope of employee NICs.”[2] Following a technical consultation, draft legislation was published in December that year, for inclusion in the Finance Bill 2017.[3] This now forms clause 5 of the Finance Bill 2017-19, which is before the House at present. It is estimated that this measure will raise just over £400m a year from 2018/19.[4]

There have been some concerns that this measure might hit individuals who will be dealing with the wider costs from being made redundant, and that the Government might cut the £30,000 exemption at some point in the future. Several Members raised this issue when the Ways and Means Resolutions underpinning the Finance Bill were debated on 6 September. On this occasion Treasury Minister Mel Stride said, “the £30,000 tax-free allowance will still be available and statutory redundancy ​will be tax-free. However, we must face the fact that, while it may be a particularly easy argument to prosecute that we are somehow beating up those who are losing their jobs, the reality is that that situation is being used as a vehicle for tax avoidance, and when the Government find tax avoidance, we will clamp down on it.”[5]

Notes: 

[1]     Review of employee benefits and expenses: final report, July 2014 p7

[2]     Budget 2016, HC 901, March 2016 para 1.145-6

[3]     HMRC, Income Tax and National Insurance contributions: treatment of termination payments – tax information & impact note, December 2016

[4]     Spring Budget 2017, HC 1025, March 2017 p29 (Table 2.2 – item ar).

[5]     HC Deb 6 September 2016 cc252-3

Commons Briefing papers CBP-8084

Author: Antony Seely

Topics: National insurance, Taxation

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