Simplification of the tax and National Insurance treatment of termination payments

A consultation has been published asking for views on how the tax and NICs treatment of termination payments can be made simpler and fairer.

The government is considering how they can make the tax and National Insurance contributions (NICs) treatment of termination payments simpler and fairer and wants to hear your views on how that can be achieved.

The consultation particularly seeks views on:

removing the distinction between contractual and non-contractual termination payments and whether this will make it easier for employers and employees to understand
the design of the new exemption from income tax and NICs
whether the income tax and National Insurance treatment of termination payments should be aligned
which of the existing exemptions which remove the liability to income tax should be retained and whether any new exemptions should be introduced.

The consultation will run until 16 October 2015 and can be found here

LEARN SOLID-TRAINING THAT WORKS FOR YOU 2014

Comment

This consultation is extremely welcome. The determination of the tax treatment of termination payments is one of the most complex areas we have to deal with in payroll with particular reference to pay in lieu of notice and whether such payments are contractual, non-contractual, damages etc.

A brief look at the proposals shows the following:

To simplify the existing treatment the government agrees with the OTS that the first step is to remove the distinction between the tax and NICs treatment of contractual and non-contractual termination payments. The outcome would be that all PILONs would be treated in the same way with the government intention that all payments made in connection with termination of an employment will be earnings and subject to income tax and employer and employee NICs. This will mean that employers will no longer need to consider which parts of a termination payment are taxable and which parts are not.

However, having said that, the government believes that there is a case for providing support in the form of tax and NICs relief when someone loses their job. This is because removing the exemption would have a significant cost impact for some people, especially those who receive smaller termination payments. Therefore the government intends to introduce a new exemption from income tax and NICs.

One approach the government is considering is to create a new exemption which increases proportionately with the number of years of service the employee has completed. This would create a new fairer exemption which will proportionately reward long serving, lower paid employees. Linking the availability of relief to the length of service of the employee would create a simple system that is easy to understand and easy for employers to administer.

The employee would qualify for the exemption once they have completed two years of service. This would mean that anyone who receives a termination payment after completing two years of service would not have to pay tax and NICs on some, or possibly all, of their award (depending on the size of their award). The level of the tax and NICs exemption would then increase at a set rate with each year of service completed up to a maximum amount.

This document is a “must read” for anyone who has an interest in this subject area.