Tax exemptions for redundancy compensation could be linked to service
The government is currently considering responses to a recent consultation on taxing termination payments for departing employees. Any changes will be announced in December.
Last year, the Office of Tax Simplification concluded that the current tax system for termination payments was complex, unfair and provided scope for tax avoidance. Errors or disagreements with HMRC occur easily and mistakes are expensive. Currently non-contractual termination payments (such as for redundancy) are not liable for NICs and are tax free below £30,000, but contractual ones are fully subject to income tax and NICs.
The consultation’s aim is to simplify the system and bring employees losing their jobs “certainty about the amount of money they will receive”.
One proposal is a blanket exemption for the first £30,000 of all termination payments, both contractual and non-contractual. But both the Office of Tax Simplification and the government consider this option financially unsustainable. Another suggestion was exempting only statutory redundancy payments from tax. This is unlikely to be adopted because large groups of workers (including employee shareholders, parliamentary staff and civil servants) do not technically qualify for statutory redundancy and additional legislation would be required to allow these groups to receive the tax and NICs exemption, adding complexity to the system.
The government’s preferred option is to exempt statutory and voluntary redundancy payments from tax and NICs, based on the employee’s service. Employees would need two years’ service to qualify for the exemption, and service with the same employer, associated employers or following a Tupe transfer, would all be counted. Whether the payment was contractual or not would be irrelevant. There is likely to be a cap imposed on how much the employee is able to receive tax and NIC free, but no mention is made of an amount.
One problem with this is that some reorganisations result in dismissals which fall short of the statutory definition of redundancy, often categorised as dismissals for the potentially fair reason of ‘some other substantial reason (SOSR)’. There can be a narrow dividing line between redundancy and SOSR dismissals and it is difficult to see why the latter should automatically be excluded.
On the plus side, if the statutory or voluntary redundancy payments exemption was adopted, the government suggests creating two new categories of tax exemption: compensation for unfair or wrongful dismissal, and for loss of future earnings following discrimination. There will be a cap, but the consultation does not set out what this will be.
Certain exemptions from tax, such as payments for injury or disability, or to the armed forces, are likely to remain, but exemption for termination payments relating to working overseas may go. The issue of share-related termination payments not being exempt from tax is not dealt with.
There is a proposal to abolish the NICs exemption for non-contractual termination payments to align this with the income tax rules. This would be a simpler approach, but will clearly prove more costly for employers and employees alike.
At this stage it is difficult to predict how tax law will change. Currently we have a confusing set of proposals which raise the possibility of more, rather than fewer exemptions, suggesting the potential for greater rather than less confusion. While removing the distinction between the taxation of contractual and non-contractual payments would be welcome, the principal aim appears to be to ensure no overall decline in tax receipts as much as the creation of an easier-to-administer system.
Sarah Ozanne is an employment partner at law firm CMS Cameron McKenna LLP
For more employment law articles, visit HR-inform
