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Draft legislation on changes to taxation of termination payments

29th August 2016

Last year we reported on a consultation paper setting out proposed changes to the tax treatment of termination payments. The tax free limit to payments for compensation for loss of employment, in the sum of £30,000, has remained unchanged for decades!

Obviously, in the time that has elapsed the value of that limit has reduced. In addition, in the intervening years there have been significant case law developments, including some contradictory case law, on the treatment of certain types of payment on termination of employment. This has resulted in a complicated situation where some payments are taxable, and others are not taxable.

The initial suggested changes included setting the general tax free limit of £6,000, then adding an extra £1,000 for each additional year of employment service. This was almost certain to significantly reduce the amount of tax free payments that most people could receive on termination of employment.

The Government has now published draft legislation setting out proposals on changes to the tax treatment of termination payments, which it proposes to introduce from April 2018.

The changes include:- Making all payments in lieu of notice taxable (whether or not the contract of employment reserves the right to the employer to make such a payment)- which is to apply if the employee is required to leave immediately or work only part of the notice period,- providing for both tax and National Insurance Contributions to be paid on all compensation over £30,000 (currently those sums are taxable but not subject to National Insurance Contributions),- removing the foreign service relief exemption for termination payments, and- ensure that payments for "injury to feelings" are taxable.

The general tax free threshold of £30,000 is to remain. The failure to raise the threshold comes as no surprise in light of the Government's aims to reduce the financial deficit. The draft legislation at least does not seek to introduce the full range of proposals made last year (which would have resulted in a significant reduction in the tax free payments within most termination arrangements. The Government has stressed that the entirety of a termination payment will be exempt from employee NICs, and that the current general threshold of £30,000 will remain. The draft legislation will clarify the situation on the treatment of compensation for injury to feelings- which is currently the subject of contradictory court rulings. 

In practice it is most likely that the main impact will arise in connection with the uniform treatment of payments in lieu of notice, which may result in employers having to reconsider their approach to how they deal with the notice periods of employees that are leaving the business under some sort of settlement arrangement.

Do not hesitate to contact us at Hallett Employment Law Services Ltd if you need assistance with any of the issues raised in this article.  

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