What is the background?
Understanding the tax and NIC treatment of termination payments can be complex. Whilst there is a tax exemption for the first £30,000 of a termination payment, the legislation is absolutely clear that this can apply only where the payment is not taxable under different parts of the tax legislation. The amounts attributable to various components of the overall calculation will need to be considered individually, rather than considering the full amount.
What is the latest development?
A recent First-tier Tribunal, the anonymised case of L v HMRC, has demonstrated the approach taken by a tribunal in considering the various components. Whilst First-tier tribunals cannot be relied on as legal precedents, this does highlight the method which should be used by employers for dissecting a termination payment and determining the tax and NIC treatment of its various parts.
What did the Tribunal consider?
In what was a fairly typical termination scenario, the taxpayer (“L”) had their employment terminated due to redundancy.
L appealed against this on the grounds of alleged discrimination, unfair dismissal and inequality of pay. Following the lodging of an Employment Tribunal claim, a settlement agreement was signed in March 2014 agreeing various payments. The employer treated £30,000 as non-taxable under the termination payments legislation, and the balance as taxable. L submitted a self-assessment return on the basis that a larger proportion was not liable to tax, thus claiming a refund of tax, and HMRC challenged this.
It was accepted that the settlement sum was not a single indivisible amount but could be broken down between a number of components summarised in the table below.
What tax treatment was decided?
The Tribunal stated “Where a global settlement sum has been paid to compromise a number of discrete claims it must be determined whether that single sum can sensibly and realistically be apportioned and attributed to the various components of the claim. Where the payment can be apportioned and attributed each portion of the payment is to be considered separately”.
The following table summarises the decided tax treatment for each portion:
| Details of claim | Decision |
| “Deferred consideration” payable under the incentive scheme | This was agreed to be taxable in full as “L” had earned the entitlement to receive the sums and had a contractual entitlement to receive them. The inclusion of the payment within a settlement agreement did not change the nature of the payment. |
| A sum to compromise future claims against the employer | This was agreed as being taxable in full. |
| A sum for injury to feelings | It was agreed that this was not subject to tax (relying on historical legislation which has since changed). |
| A sum calculated based on breach of the Equality Act, in relation to an equal pay claim | The Tribunal judged that this was fully taxable as simply deferred compensation. |
| An element related to unfair dismissal, including discrimination in the redundancy process | The Tribunal judged that this was a termination award and was taxable to the extent it exceeded the £30,000 exemption. |
| The balance relating to discrimination experienced during the employment | The amount was determined to be outside of a charge to tax because it was not paid “from the employment” because “the heart of this part of the Appellant’s claim is not that they were not fairly paid for what work they did but that they were deprived of the opportunity to perform their full role”. |
What should organisations do next?
This case highlights the importance of employers carefully considering the termination payments made to a departing employee and analysing each element to determine its tax treatment, particularly where the payment is made as a lump sum. It considers some complex areas that related to the specific circumstances but a range of other areas, such as post-employment notice pay (PENP) and terminations due to retirement that can also create compliance issues for employers.
It is important to note that if an employer fails to apply PAYE when it should, that employer may become liable for payment of that PAYE, as well as financial penalties for getting it wrong.
How UNW can help?
UNW’s employment taxes team has significant experience in providing support to clients, irrespective of their size. Our support will be provided to meet the specific requirements of an organisation and can include:
- Delivery and facilitation of training and workshops on the tax treatment of termination payments, designed to meet the specific circumstances of an organisation and involving participant discussion, and;
- Providing advice and support on the tax and NIC treatment of imminent termination payments.
If you would like to discuss how we can help you, or have any other employment taxes related queries, please get in touch with us at employmenttaxesteam@unw.co.uk
