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Proposed changes to the taxation of termination payments

22 August 2016

Parting is such sweet sorrow…or maybe not: the Government’s proposals to reform the taxation of termination payments.

The Government are proposing to overhaul the way in which termination payments are taxed. We set out below a summary of the proposals, and what this could mean in the future for settlement agreements.

The current situation

Currently the first £30,000 of a “compensation for loss of office” payment is free of tax – section 403 Income Tax (Earnings and Pensions) Act 2003 (ITEPA). This means that non-contractual payments made on termination can, on the whole, be tax free up to £30,000. This has proved an invaluable tool for employers seeking to negotiate an amicable departure with employees who may otherwise have brought an employment tribunal claim, or required a lengthy process in order to result in a fair dismissal.

This has remained unchanged for years…until now it seems.

The proposals

The Government has launched a consultation on the taxation of termination payments, which closes this week, with the stated aim of making the system “simple for employers and employees to understand”. The proposals are as follows:

  • To treat contractual and non-contractual payments the same – meaning that all payments in lieu of notice would be subject to tax and national insurance, whether they are contractual or not;
  • To provide a tax exemption on employees which rises in accordance with length of service. The proposal is that this would apply to individuals with more than 2 years’ service and would increase at a set rate with each year of service, up to a maximum amount. The consultation paper provides an example of an initial exemption of £6000 after 2 years’ service, rising by £1000 for each additional year, but it does not specify a maximum amount;
  • To consider limiting tax exemptions to cases of redundancy (including voluntary redundancy). However, the Government is considering whether further exemptions for payments made in respect of unfair or wrongful dismissal and/or discrimination should also apply.

What could this mean?

The Government’s proposals are clearly going to make a big difference to the approach both employers and employees take to negotiations on the termination of employment. For an employee who has less than 2 years’ service no tax exemption would be available, and even those longer serving employees This Information Sheet is provided for your general information only and does not seek to set out the law in this area in detail.

If you have any queries or wish to discuss specific circumstances, please do not hesitate to contact one of our team who will be happy to assist. may not benefit from any exemption where their termination is not a redundancy, or one of the other categories being considered by the Government.

This has the potential to be quite a headache, and we will keep you updated as the proposals progress.

Barlow Robbins Employment team

This Information is provided for your general information only and does not seek to set out the law in this area in detail. If you have any queries or wish to discuss specific circumstances, please do not hesitate to contact one of our team who will be happy to assist.