UK News

Proposed changes to tax treatment of termination payments

August 2015

Overview

Proposed reforms that are intended to make the tax treatment of termination payments simpler and fairer have been published in a consultation document entitled “Simplification of the Tax and National Insurance Treatment of Termination Payments”.

Concerns

Following their review of termination payments in the UK, the Office of Tax Simplifications (OTS) concluded that the complexity of the tax treatment of such payments resulted in uncertainty for both employers and employees.  

In particular, the OTS review found that currently there was:

  • A mistaken belief that the first £30,000 of any pay-off could be paid without deduction of income tax and National Insurance Contributions (NICs);
  • A lack of understanding about the distinction between contractual and non-contractual payments;
  • An unfair bias in the current system towards higher earners who are generally in a better position to benefit from tax exemptions.

Recommendations

The consultation document asks for comments on proposals, including the following:

  • Removing the distinction between contractual and non-contractual termination payments;
  • Changing the current fixed £30,000 tax free entitlement to an amount that increases with length of service; and
  • Introducing limits on when tax relief can be sought, through providing for a qualifying period of two years continuous service for any tax free entitlement or through only providing for tax or NIC’s relief where an employee is made redundant.

Comments

  • Linking the amount of tax relief for each employee to their length of service will reduce the ability of employers to offer incentives to accept compensation payments.
  • Although the consultation document does not specifically set out amounts or thresholds, an example in the consultation document suggests a £6,000 tax-free sum after two years' employment, increasing by £1,000 for each additional year of employment.  If these thresholds are put in place almost all employees will be subject to a significantly reduced tax-free sum when their employment terminates – the current level of £30,000 would only be reached after 26 years’ service.
  • If tax relief is only available on redundancy payments, the amount of employees benefiting from tax relief on termination payments will significantly diminish.

Responding to the Consultation

Any responses to the items highlighted in the consultation document can be emailed to employmentincome.policy@hmrc.gsi.gov.uk by 16 October 2015. “The government will publish details of the consultation responses and expects to make an announcement at Autumn Statement 2015 on any decisions made in light of those responses.”

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