Taxation of termination payments

‘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.[3] In turn this provision now forms s5 of the Finance (No.2) Act 2017.[4] It is estimated that this measure will raise just over £400m a year from 2018/19.[5]

There have been concerns that this measure might hit individuals dealing with the wider costs from being made redundant, and that the Government might cut the £30,000 exemption in the future. When this provision was debated at the Committee stage of the Finance Bill, Treasury Minister Mel Stride said, “the Government recognise that losing a job is a challenging time, but we must remain vigilant to opportunities for the tax rules to be manipulated … [This clause] … sets out a fair and proportionate set of changes that will continue to protect the vast majority of employees. The first £30,000 of a termination payment will remain tax-free, as will the whole of the compensation payment for discrimination during employment. However, where there were opportunities for manipulation, the loopholes must be closed, and they now will be.”[6]

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] For commentary on the new rules see, “Changes ahead”, Taxation, 15 June 2017 & “Tax on termination payments: what’s changing from 2018/19 onwards”, Tax Journal, 26 January 2018.

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

[6] HC Deb 11 October 2017 c372