James Bailey points out that whilst the £30,000 tax exemption for ‘termination payments' is a valuable tax relief, it can be difficult to successfully claim.
When an employee leaves his job, up to £30,000 of any termination payment may be exempt from income tax. If this exemption applies to a payment, then it is also exempt from employer’s and employee’s National Insurance contributions (NIC) – and the NIC exemption will apply to the whole payment, even if it is more than £30,000.
In order to qualify for the exemption, it has to be shown that the payment is not liable to tax under any other legislation, whether as employment income, or a payment for a restrictive covenant, or (as HMRC will try to argue in the case of older employees) a form of pension payment.
Not so fast!
The commonest way HMRC will attack claims for the £30,000 exemption is by arguing that the payment is made under the terms of the employee’s contract of employment. If the employee is contractually entitled to the payment, the argument runs, then it forms part of his pay and is liable to tax in the normal way. Payments for accrued holiday entitlement and payments in lieu of notice (PILONS) are the commonest categories.
Most contracts of employment will include a notice period – typically one month, but sometimes as long as one year. In some cases, the contract will also give the employer the option of terminating the employment without notice provided he pays a lump sum equal to the pay that would have been earned during the notice period.
If the contract is worded like that, HMRC will argue that the PILON is taxable as employment income because it is being paid under the terms of the contract of employment. If there is no provision for a PILON in the contract, HMRC will still try this line of argument if they think they can show that the employer had a common practice of making PILONs, so that there was an ‘expectation’ of such a payment.
Points to note
A good way to help secure the £30,000 exemption is to have a proper ‘compromise agreement’ drafted by a solicitor (and payments to a solicitor to represent the employee’s interests are also exempt from tax). Such an agreement will say that in return for a specified payment, the employee renounces all his rights against his ex-employer, and agrees he will not take any legal action in respect of the termination of his employment. Payments under such an agreement are not paid under the employee’s contract of employment – they are effectively damages paid by the employer for breaking that contract, and as such should qualify for the £30,000 exemption. In order to secure the exemption, the compromise agreement should be drafted by a good lawyer who specialises in employment law, working closely with a good tax adviser.
The £30,000 exemption can apply to non-cash benefits as well – for example, employees sometimes are allowed to take their company car with them on termination, or their health cover is continued for an agreed period.
If the termination payment is made in respect of the death or disability of the employee concerned, then any amount paid is potentially exempt from tax and NIC, not just the first £30,000. HMRC define ‘disability’ as being unable to ‘fulfil the duties of an office or employment’ as a result of a sudden illness such as a heart attack, or as the result of a process of deteriorating health.
Practical Tip:
HMRC will generally try to deny the £30,000 exemption for termination payments by arguing that the payment is something the employee is contractually entitled to. Good legal and tax advice is essential to ensure they do not succeed in their argument.
