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Home / Blog / New measures proposed to simplify the taxation of termination payments

New measures proposed to simplify the taxation of termination payments

11 August 15 | By: Jas Jhooty

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Another week and yet another consultation from HM Treasury. This week they are looking to simplify the somewhat complicated rules for taxing termination payments.

This consultation document can be found here and is seeking views on how the tax and NICs treatment of termination payments can be made simpler and fairer. Last year the Office of Tax Simplification published their recommendations to clarify the tax & NIC position of the various elements that typically make up a termination payment.

The Government have agreed with the OTS recommendations and have proposed the following changes in the consultation document: -

Proposals

The first proposal is to remove the distinction between the tax and NIC treatment of contractual and non-contractual termination payments. The outcome would be that all Payments in Lieu of Notice would be treated in the same way with the intention that all payments made in connection with termination of an employment will be earnings and subject to income tax and NIC. This will mean that employers will no longer need to consider which parts of a termination payment are taxable and which parts are not.

However the government still believes that there is a case for providing support in the form of tax relief when someone actually loses their job. This is because removing the exemption would have a significant cost impact for some people, especially those who receive smaller termination payments. Therefore the government intends to introduce a new exemption from income tax and NICs.

One approach the government is considering is to replace the current £30,000 exemption with a new exemption which increases proportionately with the number of years of service the employee has completed. This would create a new fairer exemption which will proportionately reward long serving, lower paid employees. Linking the availability of relief to the length of service of the employee would create a simple system that is easy to understand and easy for employers to administer.

The proposals are that the employee would qualify for the exemption once they have completed two years of service. This would mean that anyone who receives a termination payment after completing two years of service would not have to pay tax and NICs on some, or possibly all, of their award (depending on the size of their award). The level of the tax and NICs exemption would then increase at a set rate with each year of service completed up to a maximum amount.

Views sought

The consultation particularly seeks views on:-

  • removing the distinction between contractual and non-contractual termination payments and whether this will make it easier for employers and employees to understand
  • the design of the new exemption from income tax and NICs
  • whether the income tax and National Insurance treatment of termination payments should be aligned
  • which of the existing exemptions which remove the liability to income tax should be retained and whether any new exemptions should be introduced.

Our views

Our view is that this consultation is extremely welcome. The determination of the tax treatment of termination payments is one of the most complex areas employers have to deal with in payroll. In particular references to pay in lieu of notice and whether such payments are contractual, non-contractual or damages often result in mistakes being inadvertently made.

We will of course keep you informed of the latest developments in this and all other employment tax related matters.

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