HM Insights

Tax and termination payments: is the £30,000 exemption set to go?

In a nutshell

What’s it all about? When an employee is paid off, there can be an exemption from tax of up to £30,000. However, under new proposals this system could be about to change radically.
Why should you care? Anyone who has received or could be set to receive payment on termination of employment needs to know exactly how much of that money will stay in their pocket.
What do you need to do know? Keep an eye on the consultation process and in particular the government’s Autumn Statement.
Get in touch: Have a termination payment and want to know where you stand? Contact Bruce Caldow or visit our employment law pages and find out how we can assist.

Tax Man Employee Money

The full story – how making things simpler can get complicated

The taxation of termination payments is, unfortunately, rarely a straightforward consideration for employers or employees. There is an exemption from income tax and National Insurance Contributions (NICs) for non contractual payments on termination of employment of up to £30,000, but there is often a degree of uncertainty over what is truly a non contractual payment. This is often a particular concern regarding a payment in lieu of notice.

There are moves to simplify this process of tax and NICs treatment – but this proposed simplification has it own repercussions.

On 24 July 2015, the government published its consultation paper, in response to a report issued by the Office of Tax Simplification in 2014, which identified the current tax treatment of termination payments as ‘fraught with confusion and uncertainty’.

The simplification measures being considered by the government include:

  • Removing the distinction between contractual and non-contractual termination payments;
  • Aligning income tax and NICs treatment of termination payments;
  • Changing the fixed £30,000 tax-free sum to an amount which increases proportionately with the employee’s length of service;
  • Introducing a two year qualifying period for receiving a tax-free termination payment;
  • Linking the tax exemption to termination of employment on redundancy only; and
  • Making injury to feelings awards wholly or partly subject to tax.

Although it is yet to be confirmed, the government has made reference to a £6000 tax-free sum which would be applicable once an employee has over two years’ service, increasing by £1,000 for each additional year of employment.

How will this affect an employee’s pocket?

If all these proposals were to be introduced, it would certainly remove the dubiety from whether payments in lieu of notice (and other contractual payments) were taxable or fell within the exemption.

However, the changes to the current regime would be significant. The equivalent of the £30,000 tax free amount would become achievable by an employee with over 25 years’ service and only if the reason for termination was redundancy.

The tax free exemption, although simplified, would become only applicable in a much reduced range of situations and – for most employees – at a much reduced level. This would lead either to an employee having to accept less than they would have previously received or an employer having to “gross up” the payment in order that an employee receives the equivalent, with clear cost implications.

Further, although the confusion regarding contractual/non contractual payments would be cleared up, if this tax exemption was linked to a redundancy dismissal, then we can see an analogous situation where there may be confusion over whether a dismissal is genuinely by reason of redundancy – and indeed how far down a redundancy process an employer would have to go before the tax free exemption would be able to be applied.

Equally, there is no clarity as to whether this reduced threshold would be applicable to awards related to claims for unfair dismissal in the employment tribunal – currently also subject to the £30,000 exemption.

These proposals are, of course, not certain to be implemented – views on this issue are being sought until 16 October, with a further announcement expected in the government’s Autumn Statement. For more information on the proposed changes, the consultation paper can be found here.

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