The taxation of termination payments

08 Sep 2014

The Office of Tax Simplification is completing a final consultation into the taxing of termination payments made to employees at the end of their employment. The government believes that these payments give rise to confusion over how they should be taxed.

As the law currently stands, if an employer makes an employee redundant or an agreement is reached between the employer and employee to end the employee's employment, then it is usual for that employee to receive a termination payment. This payment will usually consist of a redundancy payment (either statutory or enhanced) and/or a payment for loss of employment. In this situation, there is a tax relief, under section 403 ITEPA 2003, that allows for the first £30,000 of the termination payment to be made tax free.

All other contractual payments, such as notice pay, outstanding salary and accrued but untaken holiday, are subject to the usual income tax and national insurance deductions.

The new government proposal is aimed at simplifying the taxation of a termination payment and only payments of statutory redundancy will be made tax free to a departing employee. Therefore, all other payments made to a departing employee including an enhanced redundancy payment and payments as compensation for loss of employment will be subject to the usual tax and national insurance deductions.

Whether or not this change comes into force is yet to be decided, but considering the potential increase in revenue for the government it is looking more likely than not. It is likely that the ministers’ formal responses to this report will be available in the Chancellor’s Autumn Statement. Further updates will follow in our newsletter as the matter evolves.