Is the £30,000 tax exemption for termination payments about to change?
Many employers will be familiar with the ‘£30,000 tax exemption’ for employee termination payments. When you terminate an employee’s employment, their financial package can include several different elements, such as accrued holiday pay; a payment in lieu of notice (PILON); statutory redundancy pay; and a compensation payment. Some of these elements will be subject to tax and national insurance contributions (NICs), but others will benefit from a £30,000 tax exemption and a blanket NIC exemption (with tax only due on the excess over £30,000).
What are the proposed changes?
The government is now consulting on proposed changes to the tax treatment of termination payments. It is proposing to:
- Remove the current distinction between different types of payments, so that the starting point will be that all payments made in connection with termination of employment will be subject to income tax and NICs – both employee and employer NICs.
- Align the income tax and NICs treatment of termination payments, so that any amount subject to income tax is also subject to NICs.
- Replace the flat £30,000 exemption with one that:
- only applies in cases of genuine redundancy (voluntary or compulsory);
- only kicks in when an employee has two years’ continuous service with the same employer;
- increases proportionately with length of service (up to a maximum);
- does not apply to payments made through salary sacrifice, flexible benefit or similar arrangements;
- will not be available for employees accepting a reduced salary in return for a termination payment;
- will not apply to those resigning in return for payment; and
- will cease to apply if an employee is re-engaged by the same employer to perform the same or a similar job within 12 months (i.e. the exempt payments would become chargeable).
- Introduce a new exemption for payments in connection with wrongful or unfair dismissal. It asks in the consultation whether these should be capped, and whether payments made via a tribunal award, and those made via arrangements between an employer and employee, should be treated differently.
- Introduce a new exemption for tribunal awards made as compensation for discrimination.
- Retain some existing exemptions, including the exemption for injury or disability.
- Possibly remove the existing exemption for employer contributions to employees’ legal fees in taking advice on settlement agreements.
The government argues that the proposed new system will simplify the taxation of termination payments. One of the government’s particular stated aims is to remove the current confusion surrounding the tax treatment of PILONs (by making them all taxable). At present, if you have an express contractual right to make a PILON, that payment will be subject to tax and NICs. However, if you dismiss without notice, and have no contractual right to make a PILON, any payment in a termination package in respect of notice will be viewed as ‘damages for loss of notice’ and covered by the £30,000 exemption. Contrary to its stated aim, it appears that this distinction between taxable and exempt PILON payments will remain under the government’s proposals, because payments which are ‘damages for loss of notice’ will be covered by the new exemption for wrongful dismissals.
For employers, the proposals are likely to push up the costs of termination in some circumstances, including where employers find themselves paying employers’ NICs which would not be due under the current regime.
For employees, we will only be able to quantify the full effects when the exemption rates are set, but there is no doubt that many will have less money in their pockets after a termination than under the current system, although some may push for a higher settlement figure to compensate for this.
How to respond to the consultation
You can access the consultation here and, if you would like to respond, you will need to do so by 16 October 2015. A summary of the responses and an announcement on any decisions is expected during the 2015 Autumn Statement.
Other employment tax changes in the pipeline
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