There goes the incentive to terminate…?.

Often the incentive of being able to pay the first £30,000 of any non-contractual termination payment tax and NI free forms the basis of negotiations for our clients when discussing severance packages. It has long been a useful tool where non-contractual termination payments and/or enhanced redundancy payments are being considered.

However, this comfortable status quo for our clients may soon come to an end as the Government proposes to tax all termination payments except those attracting the new, limited exemptions.

The Government has been advised that the current tax treatment on termination payments allows only those who are better paid and better advised to structure their affairs so that they benefit from the tax exemptions, whereas the majority of employers and employees remain confused by the complexity of the tax rules.

With that in mind, the Government has announced its intention to reform this area by consulting on how to simplify the tax treatment of termination payments whilst also making it affordable for the Exchequer. The current proposals are to:

• Remove the distinction between contractual and non-contractual payments (so that all payments made in lieu of notice are treated the same);
• Treat all termination payments as ‘earnings’ and therefore subject to income tax and NICs;
• Align the NIC treatment with the tax treatment of termination payments;
• Crucially, introduce a new exemption from income tax and NICs on termination payments, which:

  • increases proportionately with the number of years of service the employee has completed;
  • introduces a two year qualifying period, so no employee can receive a tax-free termination payment unless they have been working for at least two years for the same employer;
  • only applies where the termination payment is being made in connection with a ‘redundancy’ – as defined in the current legislation.

There will be anti – avoidance provisions in place to ensure that the new regime only supports those who lose their job through no fault of their own (including voluntary redundancy).

Practical effect: The days of short service employees receiving tax relief on carefully crafted settlement payments (often paid on their resignation or by mutual consent), may be numbered if the government chooses to adopt these new proposals. The new regime, if adopted, would provide for more limited circumstances in which tax and NI free payments could be made but may provide greater benefit to longer service employees receiving deduction free payments in lieu of notice.

The Government consultation will run for from 24 July 2015 until 16 October 2015 – watch this space for the update thereafter….

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