As Rachel indicated last week, the Government has published a Consultation document on the "simplification" of the tax and national insurance treatment of termination payments. Consultation runs until 16 October. This follows the Office of Tax Simplification's final report on employee benefits and expenses published a year ago.
Under the current system termination payments to which an employee is contractually entitled are generally subject to income tax and NICs. Redundancy payments and other compensatory payments are generally not, up to a limit of £30,000. The rules are not straightforward and there is considerable, but not perfect, alignment between the income tax and NICs rules. [The Government is at least looking at a possible amalgamation of income tax and NICs separately.]
One theme which emerges strongly is that the better paid tend to be better advised, and are often able to structure their affairs so they benefit from the tax exemptions. What evidence there is that the lower paid do not get tax free termination payments I'm not sure, but one point made by the OTS was that often the £30,000 exemption was applied to parts of termination packages which should have been taxed.
The purpose of this blog is not so much to alert you to the details of the consultation document (available here) but rather to warn employers and employees alike that simplification is likely to mean a reduction (possibly a significant reduction) in the relief available. The distinction between contractual and non-contractual payments may disappear, meaning that smaller termination packages may escape tax altogether. However, the current £30,000 exemption (unchanged since 1988) is described as not affordable, if that distinction is to be abolished. [If the £30,000 exemption had been inflation adjusted the figure would now be over £70,000.] The tax relief which will be available to termination payments may be graduated, according to length of service.
There are indications that the total exemption for termination payments made on injury/disability will survive, as will payments into pension schemes within the limits set in the tax legislation. The latter seems unsurprising in circumstances where tax relief for payments into pension schemes has been eroded so much already.
The very valuable foreign service exemption – available for those who spend parts of their careers abroad – looks to be vulnerable, but there is a suggestion that compensatory payments for injury to feelings may escape the tax net.
If anyone wishes to comment on the Consultation document, he/she may do so. The usual government rules about the confidentiality of your comments apply.