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Tax treatment of termination payments “simplifying”

12 August 2015

The Government has launched a consultation with a view to over-hauling the way in which termination payments are taxed.

Those used to dealing with termination payments will be aware of the tax exemption on the first £30,000 of compensation for loss of office. This does not apply to contractual payments (e.g. payments in lieu of notice, or payments in lieu of accrued but untaken holiday).

The Government’s proposals include:

  • Removing the distinction between contractual and non-contractual payments. This will mean that all payments in lieu of notice will be treated in the same way “as the government understands that there is widespread confusion over the treatment of these types of payment”;
  • Imposing a new tax exemption regime which would see the old £30,000 limit disappear, in place of a system which provides for an increasing amount of tax exemption depending on the length of service of the employee; and
  • Imposing a qualifying period of two years’ service before employees can receive any tax free saving on termination payments.

Whilst the consultation document is silent on the specifics of the proposals, some commentators have suggested that the tax free compensation amount would start at £6000 after two years’ service, rising by £1000 a year. The effect of this will be to vastly reduce the tax free element of termination payments.

This will result in increased tax revenue for the Government, but it raises questions over whether this will assist employers in amicably reaching agreement with departing employees in many cases, and effectively avoid expensive litigation.

The consultation is open until 16 October 2015.