I recently wrote a blog on Settlement Agreements entitled “What should you be aware of?” In my blog, I discussed the common misconceptions we come across when we help a client with a settlement agreement. One of those issues was the amalgamation of contractual and non-contractual payments.
A payment upon termination of employment normally consists of different elements:
• Non-contractual payments. These can either be a redundancy payment, a payment in lieu of notice (PILON) (or, if the contract does not allow such payment, a damages payment) or compensation for breach of contract.
• Contractual payments. Such as a final salary payment, accrued holiday, and a contractual PILON payment.
To date, it has generally been viewed that the first £30,000 of a non-contractual termination payment can be paid free from deductions of tax and national insurance (disclaimer: I am not a tax adviser!).
However the Government is proposing yet another change to employment law. Employers may be disappointed to learn that payments up to £30,000 which are deemed to be free from tax and NI, may become yesterday’s news. The reason for this is that the Government believes this is proving too complicated for employers and HMRC when it comes to determining the true nature of each part of the termination payment.
So what’s the proposal?
The government is proposing to replace the current tax treatment of these termination payments with what they say is a simpler regime, which will consist of new exemptions on termination payments. This involves potentially abolishing the £30,000 tax relief and replacing it with a new exemption for all payments made to employees in connection with termination of their employment where their employment ends through no fault of their own.
So, how does this work for capability and performance related dismissals, or for those dismissals that are by ‘mutual agreement’?
In order to qualify for the relief, the employee would need to complete at least two years’ service and the amount of relief they are entitled to would depend upon length of service – there is a maximum amount although the government is yet to disclose this (however I fear that it won’t be anywhere near the £30,000 limit we have now). Anything above the threshold will be subject to tax and national insurance deductions for both employers and employees.
Whilst the proposal seems to imply the relief may be restricted to redundancy situations only, there may also be new exemptions for compensation for unfair/wrongful dismissal; and discrimination. Of course it’s yet to be seen how terminations that fall into more than one category will be dealt with!
How will this affect you as an employer?
Well, there’s good and bad news:
1. An advantage is that employers may spend less time considering whether the termination payment is contractual or non-contractual and what the tax payment, if any, will be. Another advantage is that you may not receive comments from a lawyer on the other side of the settlement agreement advising you that part of the termination payment is taxable and therefore needs to be expressly set out in the agreement.
2. The disadvantage, however, is that it seems as though many termination payments which go above the new exemption could be subject to employer and employee national insurance. This subsequently means that, due to the additional tax, employers may need to offer greater termination payments to compensate the employee for the additional tax liabilities, and you will also have to pay the Employer’s National Insurance Contributions. The process of settlement agreements could become much more expensive for employers.
Remember, this is only a proposal for the time being so please do not take any action based on the information above, but we shall keep you updated with any developments.
This is an interesting proposal from the Government. Over recent years they have introduced new measures to give employers more flexibility in hiring and firing, the qualifying period for protection from unfair dismissal has been increased from one year to two years, and the concept of a ‘Protected Conversation’ has been introduced. However this latest proposal seems to be counter-productive, making settlement agreements a less attractive (and costly) option to both employers and employees.
Further details of this proposal can be found in the Government’s consultation paper, Simplification of the tax and national insurance treatment of termination payments . Closing date for comments is 16 October 2015 so get your comments in!
For advice please contact our team.