Whether or not a payment made to an employee on termination of employment can be paid tax free has caused all sorts of confusion over the years. For example, a lot of people think that if the employee is being made redundant, he or she can automatically receive up to £30,000 tax free. However, it is not that simple. There are a number of issues that need to be taken into account and many termination payments are subject to tax and national insurance contributions.
The Government is looking to simplify this area and has launched a consultation on its proposals.

The idea is to introduce a system that is simple for employers to administer and which gives employees certainty about how much they will receive. At the moment, employees are often faced with tax indemnities in Settlement Agreements and they are understandably nervous about any liabilities they may face.

What are some of the proposals?

  • That all payments made on termination will be subject to income tax and National Insurance unless an exemption applies
  • Exemptions for employees who lose their job through no fault of their own (not if they choose to resign or if they are employed under a fixed-term contract which expires)
  • Changing (and probably reducing) the fixed £30,000 tax-free sum to an amount which increases the longer an employee has worked
  • Introducing a two year qualifying period, so no employee can receive a tax-free termination payment unless they have been working for two years
  • Exempt payments would come back into the charge to tax if the employee is re-engaged to perform the same, or a similar, job for the same, or an associated, employer within 12 months of the termination.

The proposals are likely to mean that a significantly reduced tax-free sum is available for most employees when their employment terminates.

The Government’s consultation is open for comments until 16 October 2015. The Government intends to publish a summary of responses and to make an announcement on any decisions made in light of them as part of the 2015 Autumn Statement.

For more information please contact Alison Gair in our Employment Department.

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