20 July 17 | By: Jas Jhooty
This week we conclude our masterclass that seeks to provide an understanding of the correct taxable position of the various elements that can make up a termination package.
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.
This week’s second part of this Masterclass concludes with:
On termination, payments may be made to recognise that the employee is contractually entitled to be given notice. A payment made on dismissal of an employee which is not referred to in their employment contract, without the notice to which the employee is entitled is not general earnings but taxed under termination legislation as it is not made for being or acting as an employee.
Conversely if the employee is given proper notice, paid for that period and either chooses not to work or is told that they do not have to attend work (garden leave) is taxable as general earnings because it is being paid for being an employee during the notice period.
If the employment contract specifically provides for a PILON this will be contractual and taxable as general earnings. If PILONs have been routinely paid in the past HMRC will infer that they are taxable as general earnings.
Any verbal agreement made before the termination is in prospect will be a variation in the terms of employment and will be assessable as general earnings.
However where payment is made during the termination process it will be for the destruction of the employment contract and is taxable within termination payment legislation.
EMI Electronics v Coldicott 1999 it was held that a PILON was contractual because the employer reserved the right to make such a payment. The payment was taxed as general earnings.
Rowley v Cerebus Software Ltd 2001 provided further clarification in that there was an identical contractual provision to the EMI case, as the employer could terminate an employment contract by making a PILON.
The difference was that the employer successfully argued that they had not exercised its right under the contract by neither providing notice or made a PILON. Instead they stated that they had breached the contract and then paid an amount of damages for the breach that was less than the sum payable under the contract.
If the payment is substantially the same as that provided under the contract and is paid at the company’s discretion it will be taxed as general earnings.
Any payment made as a result of a company’s decision not to exercise its discretion can be seen as being compensation, especially if it less than what the employee may have been expecting.
If the employer can demonstrate that there is no expectation or custom of them habitually making PILONS and that each case is critically assessed on its own merits, this does not make the payment contractual since different employees can receive different payments based on their circumstances.
These are normally included as a nominal sum (£100) in settlement agreements to prevent the departing employee from working for a competitor, soliciting colleagues or clients etc. These are subject to tax & NIC in the same way as general earnings.
The value is kept deliberately low because if the employer was ever going to sue an ex-employee for breaching this condition it needs to be able to be demonstrated to the courts that the nominal sum in no way represents the true value of the damage that the employer has incurred. Therefore the employer can seek much higher damages from the ex-employee. In practice these restrictive covenant clauses are not indefinite and have a shelf-life of about 6 -12 months.
Settlement agreements are common where you
They normally comprise of various elements, PILON, statutory redundancy, ex-gratia payment/enhanced redundancy, damages for breach of contract, in exchange for
Each element needs to be looked at separately to ascertain the correct taxable position. If the employment contract specifically provides for a payment of a sum then that contractual payment is always taxed as general earnings.
Year of assessment
Tax is due in the year that they the monies are received by the employee. Any ongoing Benefits-in-kind are taxable for the period that they are made available to the departing employee.
You can negotiate paying a proportion of the settlement figure in the following tax year when the employee will have a new set of tax allowances available to them.
Pension scheme contributions
As long as a separate amount that relates to a contribution towards an approved personal pension arrangement is identified in a settlement agreement, this amount will not fall within termination payments legislation can be made tax free
Permanent health insurance payments
On occasion an employee who is on long term sick leave may be made redundant. Usually the sick pay is covered by a Permanent Health Insurance (PHI) contract taken out by the company. If there is no chance of the employee coming back to work – permanent debilitating disability (e.g. brain injury), then a redundancy situation could arise. A settlement agreement is usually entered into and depending on what is agreed there are different taxable outcomes.
If the PHI company is offering a lump sum to buy the contract out (i.e. no more monthly payments to be made) then you may be able to get HMRC to agree that the compensation is being offered wholly on the grounds of a permanent injury/long term disability and is exempt from termination payments legislation & can be paid entirely tax & NIC free
However if the Settlement agreement transfers the PHI policy from the employer to the employee then this is classified as a pension and would be deemed to be subject to income tax.
The key changes are
Statutory redundancy notice periods
In the absence of any identified PILON clauses in the contract you revert back to the statutory redundancy notice periods which are:
You have to look at the different elements of a settlement agreement. Anything contractual is to be taxed as general earnings:
Any claims for discrimination made after notice has been provided have to be taxed under termination payments legislation. It is only settlements agreed for claims to discrimination before the notice has been given that can be classified as damages and paid tax free
Up to April 2018, a payment for a breach of an employment contract that is a smaller amount than the amount stipulated in a PILON clause may be able to be paid under termination payments legislation instead of general earnings legislation.
After April 2018, all PILONs are taxed as general earnings even if there is nothing stated in the employment contract, in which case pay relating to statutory redundancy notice periods will have to be taxed as general earnings.
Redundancies arising after long term sickness may be able to be made tax-free (after obtaining HMRC’s clearance), if the redundancy is wholly attributable to a permanent disability.
Finally, payments into an approved pension scheme can be made tax-free as long as they are identified separately in the Settlement agreement.
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.