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Termination Payments
When a business and a member of staff go their separate ways, the tax status of any termination payment can be a significant issue for both parties. In the current economic climate, where more businesses are considering redundancies, employers need to be clear where they stand.
Statutory redundancy payments are tax and national insurance free and generally, where a payment represents genuine compensation for an employee being made redundant, an additional payment, where the total compensation does not exceed £30,000, will also be free from tax and national insurance. Anything above that figure is added to the employee’s earnings for that year and will be taxed at the appropriate rate along with any other payments made on termination such as bonuses and holiday and sick pay.
A more contentious area arises over the tax treatment of payments in lieu of notice – known as PILONs – when an employment relationship is terminated.
Employment contracts (which can also include documents such as a staff handbook, a letter of appointment or an employer-union agreement) may contain a clause allowing the employer to terminate the employment immediately, without the member of staff working any notice, by making a PILON. Such a clause means that a termination can occur immediately, but without any breach of contract.
Where PILONs are contractual, they are regarded as taxable: where they occur outside a contract, they may be free of tax and national insurance.
HM Revenue & Customs (HMRC) has, however, tended to take the view that such payments are taxable, even when not arising from the employment contract, if the PILON has become automatic on the cessation of employment.
This is designed to catch employers who regularly make PILONs when terminating employment; HMRC's view being that such payments arise from the employer/employee relationship rather than being damages for the breach of the employment contract.
A 2001 ruling highlights the caution with which employers need to approach PILONs. A Mr Delaney’s contract of employment allowed for termination providing he received 18 months’ notice or a PILON.
When his employer wrote to inform him that his employment was to be terminated at a future, unspecified date, they requested him to take immediate “garden leave” on full salary and benefit. Mr Delaney and his employer subsequently agreed a severance package in excess of £30,000.
The general commissioners for taxes, who hear disputes on tax issues, ruled that the first £30,000 was tax-free, however, the tax inspector appealed to the High Court. The court agreed with the inspector that the employer had complied with the contract of employment by giving written notice and although the severance package was not exactly as the contract indicated, it did not differ significantly. Thus the termination payment arose from a contract of employment and was taxable.
If you would like further information on the tax implications of payments related to redundancy and termination of employment, please contact us.