Taxation of termination payments updated legislation published
19 September 2017
The Government proposes to make a number of changes to the tax and national insurance (“NI”) treatment of termination payments.
As we have previously reported, draft legislation was initially published for comment in December 2016. The recently published Finance Bills 2017 and 2018 contain the latest version of the legislation – the one likely to be enacted.
The rules regarding non-contractual payments in lieu of notice have been considerably simplified but the circumstances in which foreign service exemption or relief will be abolished have been widened.
Under the Finance Bill 2017, the following changes will apply to payments made on or after 6 April 2018:
- The employer NI rules will be aligned with the income tax rules, so a termination payment which benefits from the £30,000 tax exemption will be subject to income tax and employer Class 1A NI on any amounts over £30,000. The existing employee NI exemption will be retained, even if the payment exceeds £30,000.
- The distinction between the different types of payments in lieu of notice will be removed. In broad terms, the basic pay that the employee would have received had they worked out their notice is subject to tax and NI in full irrespective of whether there is a clause in the employment contract giving the employer the right to terminate the employee’s employment by making a payment in lieu of notice. Basic pay for these purposes is the employee’s pre-salary sacrifice pay in the pay period immediately prior to the date on which notice is given or, if no notice is given, the date the employment terminates. Basic pay excludes overtime, bonus, commission, allowances, share and share option gains and benefits in kind.
- The “disability exemption” will expressly not apply to compensation for injured feelings, unless the injured feelings amount to a psychiatric injury. The disability exemption provides a 100% tax exemption for termination payments made only on account of the employee’s disability or injury where the disability or injury prevents the employee from carrying out the duties of their employment.
The Finance Bill 2018 contains provisions to ensure that those employees (other than seafarers) whose employment terminates on or after 6 April 2018 and who receive a termination payment on or after 13 September 2017 will not be able to claim “foreign service exemption or relief” if they are tax resident in the UK in the tax year in which their employment terminates. Under current law, some or all of a termination payment paid to an employee with a period of foreign service during their employment may be exempt from income tax depending on the length of their foreign service compared to their total service. The new rules could affect a number of individuals, given that it is common for employees whose employment terminates whilst they are on an international secondment to return immediately to the UK.
Residence status for these purposes will be determined in accordance with the normal statutory residence test. Under the statutory residence test both the number of days the individual is present in the UK and the number of ties the individual has with the UK are considered.
Whilst the simplification of the rules around payments in lieu of notice is welcome, overall these changes will have significant practical and cost implications for employers and employees. Employers will need to factor in the additional costs in their settlement negotiations.