Home / Blog / Masterclass on termination payments – Part 1

Masterclass on termination payments – Part 1

6 July 17 | By: Jas Jhooty

redundancy

Introduction

Over the next two weeks we are presenting a masterclass that seeks to provide an understanding of the correct taxable position of the various elements that can make up a termination package.

Part 1
The first part can be accessed here and provides an explanation of termination payments legislation including redundancy payments and compensation for damages. Pertinent tax cases and examples have also been detailed to help give a better understanding of the concepts involved.

Part 2
Part 2 of this Masterclass concludes with:

  • an explanation of the reasons why certain elements are deemed to be taxable as general earnings (such as PILONS and restrictive covenants)
  • as well as a description on how to best plan the negotiations for your settlement agreements
  • and also bring you up to date with a brief overview of next year’s planned changes to termination payments legislation.

Taxation

There are various elements that can form part of a termination payment. Each element has to be identified separately with a value assigned to it. There are three main tax consequences arising:

  • An element is considered to be general earnings so requires full payroll taxes of income tax and Class 1 NIC (both employer’s & employee’s) deductions
  • A constituent element falls within the definition of termination payment legislation and the first £30,000 can be paid tax free. There is no NIC up till April 2018 after which Class 1A NIC is due on any excess over £30,000
  • A constituent element can be classified as being damages not related to the employment and also does not fall within termination payments legislation and can therefore be paid tax & NIC free

Termination Payments

Any payments and/or benefits that are made that are in relation to

  • A termination of a person’s employment
  • A change in the duties of a person’s employment
  • A change in earnings from a person’s employment

Which are not otherwise chargeable to tax are assessable under termination payment legislation to the extent that they exceed £30,000. From April 2018 Class 1A NIC is applicable on the excess above £30,000

Definition of redundancy

The statutory definition of redundancy means that redundancy involves a reduction in need for employees in the business. A dismissal is by reason of redundancy only when it is caused by such a reduced need. This reduced need can arise in many ways, for example because of:

  • disposal of part of the business, or
  • relocation of the business, or
  • the introduction of new methods of work that reduces the number of employees needed.

An employee may also be dismissed by reason of another employee’s redundancy. For example, employee A’s job disappears because the place of work is closed but it is employee B who is dismissed. The employer wants to retain A. Employee B’s dismissal is often called a bumped redundancy but remains in law a redundancy. Particularly in large-scale redundancy programmes, bumped redundancies may be common. Redundancies can also be voluntary.

The essential point is to be satisfied that the total number of redundancies matches the reduced need for employees.

Statutory redundancy payments

Employees are be entitled to statutory redundancy pay if they have been working for their current employer for 2 years or more. They will get:

  • half a week’s pay for each full year they were under 22
  • one week’s pay for each full year they were 22 or older, but under 41
  • one and half week’s pay for each full year they were 41 or older

The length of service is capped at 20 years.

If an employee was made redundant on or after 6 April 2017, their weekly pay is capped at £489 and the maximum statutory redundancy pay they can get is £14,670.

Statutory redundancy pay is exempt from tax as general earnings and is assessable under termination payment legislation.

Non statutory redundancy pay /Enhanced redundancy pay

Prior to the tax case, Mairs V Haughey 1993, HMRC used to contend that any element of the redundancy payment that was not statutory was related to the employee’s expectation of a reward for past services – taxable as general earnings.

Since Mairs V Haughey 1993 HMRC accepts that genuine non-statutory redundancy payments are assessable under termination payment legislation. This tax case decided that a non-statutory redundancy payment was compensation for not receiving earnings from the employment rather than earnings from the employment itself.

Non contractual or “ex gratia” payments are examined closely by HMRC to see if they are related to past services in which case they should be taxed as general earnings.

Payments on change of functions or salary

Compensation can be made for the following scenarios:

  • If an employee is required to do the same job but for a lower salary
  • Senior employee is demoted because they cannot fulfil the job requirements
  • A post is being reduced in importance after company reorganisation

These payments can be made under termination payments legislation as long as it can be proven that these are not artificial payments/disguised bonuses, because effectively one employment has ended and another has commenced. HMRC insist that the change in duties or terms must be fundamental.

Re-engagements

If the employee is genuinely being made redundant there should be no issues.

However a re-engagement in a new job before the old one has ended or a re-engagement in job with new terms & conditions that lasts more than 4 weeks, may cause HMRC to suspect that the redundancy was not genuine and any payments should have taxed as general earnings.

Ongoing Benefits-in-Kind

Any ongoing benefits-in-kind have to be calculated using the normal benefits rules and the resulting cash equivalents need to be added to compensation sum. An easier method would be to reduce the £30,000 exemption by the cash equivalent values. For benefits-in-kind that are ongoing into future tax year a return has to be made to HMRC and the ex-employee.

NB this is not a P11D return and the benefits should not be included in your 2016/17 Class 1A NIC calculations.

Foreign Service Exemption/Deduction

Non residents can be taxed under termination payments legislation on redundancy but they may be eligible for Foreign Service Exemption

  • The employee has worked abroad for three quarters of their total employment period with the employer, or
  • The total period of employment exceeded 10 years and the foreign service comprised the last 10 years, or
  • The total period of employment with the employer exceeds 20 years and the foreign service element comprises one half of that period, including any ten of the last 20 years.

Foreign Services Deduction
This is applicable on any amounts that exceed £30,000 and is calculated as the proportion that the foreign service bears to the total service up to the termination/change date.

Legal costs

Any legal costs paid by the employer on behalf of the employee as a result of successful action by the employee are now exempted from termination payments legislation.

Counselling costs

As long as these are provided for the purposes of enabling the employee to adjust to the change or provide advice/training on how to find other gainful employment then these costs are exempt.
Any travel and subsistence paid for this kind of counselling is exempt too.

Damages

An employee may begin an action for damages where the terms of their employment contract are breached. The employer may also be liable for damages if taken to court for the following reasons:

  • unfair dismissal,
  • wrongful dismissal,
  • constructive dismissal,
  • racial harassment,
  • discrimination,
  • failure to observe H&S legislation,
  • equal opportunities,
  • equal pay.

Any payments relating purely to damages are not taxable as general earnings as they are not contractual

Gourley principle

The Gourley principle states that in a case where damages for breach of contract are being sought, the employee should be no better or worse off than if the original contract had been carried out. Therefore the amount of damages due must be the calculated net of tax & NIC. As no tax or NIC is actually paid the employee cannot claim a repayment of any deductions.

A Gourley adjustment to a payment does not prevent it from being contractual in nature and hence be taxable as general earnings rather than under termination payments legislation.

However HMRC accept that where a sum is determined after negotiation this does not mean it is not a damages payment. Non-contractual payments benefit from the first being £30,000 being tax free.

Tax Case – Crompton v Revenue and Customs Comrs TC12 2009

The employee was a non-regular permanent army clerk whose job had been “civilianised”, but as a civilian he was not allowed to apply for it. He unsuccessfully applied for other roles in the army and eventually he was made redundant. He subsequently discovered that he had been wrongly advised that he wasn’t eligible for one of jobs he had applied for.

He therefore applied to the Army Board for compensation for unfair treatment in the job selection process and received a substantial payment. HMRC taxed this as a termination payment, but the court ruled that there was no link between the compensation and the fact that the employee was no longer working in the Army.

He was eligible for the compensation payment even if he had commenced another role in the Army so as it was not linked to termination it was classified as damages with no tax or NIC due on it.

Discrimination element

Any part if a settlement that can be attributable to discrimination occurring before the termination should be accepted by HMRC as damages i.e. non-taxable. However, where the compensation relates only to the consequences of the termination e.g. loss of earnings, it is associated with the termination so is taxable under termination legislation.

By contrast if there was any discrimination before the termination, then that element for injury to feelings before the termination can be paid as damages.

E.g. The Armed forces used to routinely sack pregnant soldiers. Compensation was paid that was taxed under termination payments legislation as the discrimination occurred on their sacking and was not related to any earlier event.

Bank charges

Normally payment of an employee’s bank charges would be seen as a benefit-in-kind, however if it occurs as a result of the employer breaching the employment contract (e.g. not paying the employee on time) then the reimbursement of bank charges is deemed to be damages – not taxable as general earnings tax & NIC free.

How emTax can help

We are sure that our Masterclass on Termination Payments will be of immense value to our readers. The guide has been written in the easy to understand language that we have become well known for.

Please do not hesitate to contact us if you require any more information on termination payments or an any other employment tax matter.

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