HMRC publishes response to the consultation on tax treatment of termination payments

In July 2015 the government held a consultation with a view to simplifying the tax and National Insurance contribution treatment of termination payments.  On 10 August 2016 HMRC published the government’s response to that consultation and an explanation of how the government has decided to change the tax treatment. 

Its publication contains the draft legislation designed to implement the changes, which is expected to take effect from April 2018, and seeks views on whether the draft achieves the government’s objectives.  The closing date for comments is 5 October 2016. 

Government objectives for simplification
The government initiated the July 2015 consultation on the simplification of tax and National Insurance contribution (NIC) treatment of termination payments with a view to:

  • simplifying the taxation rules;
  • ensuring the rules are fair but not open to abuse or manipulation;
  • providing certainty for employees and employers; and
  • continuing to provide support to those who lose their job.

The government’s concern with the current tax rules is that employers can, in some circumstances, change the nature of taxable payments, such as bonuses, so that they fall within the current exemption for termination payments when they would otherwise be subject to income tax and employee and employer NICs.

Planned changes to the taxation of termination payments
The changes that the government intends to make are:

  • any payment in lieu of notice will be subject to income tax and Class 1 NICs irrespective of whether the employee’s contract of employment contains a clause permitting their employer to pay in lieu of notice;
  • employer NICs will be payable on termination payments above £30,000 (currently subject to income tax only);
  • payments for injury to feelings will be subject to tax (clarifying the conflicting case law on this issue); and
  • the foreign service relief exemption will be removed.

However, the first £30,000 of any termination payment will continue to benefit from an income tax exemption and the entirety of a termination payment will be exempt from employee NICs.  The government response stresses that they have chosen to maintain this exemption in order to help those who lose their jobs. 

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