In all the time that I have been dealing with employment claims (quite a long time!) there has been a permanent confusion concerning the tax treatment of settlement payments. Should tax be deducted from notice payments? Is there a “payment in lieu” clause in the contract of employment? Should the £30,000 exemption apply? Why should damages be taxed? Almost everyone who deals with employment claims will confront this issue at some point or another and will find people who are adamant that their respective yet conflicting positions are correct.
Now, the Office of Tax Simplification (did you know it existed?) has published a report in which it seeks to resolve these dilemmas once and for all. It has taken a while bearing in mind that it was announced in the Chancellor’s Autumn Statement in 2012. The report recognises that there is a commonly held misconception that all pay-offs fall within the £30,000 tax free exemption and similar misunderstandings concerning which parts of a settlement are tax free. The proposals are summarised as follows:
We believe that payments made in connection with a termination of employment should remain subject to income tax in principle, that certain exemptions should apply, but that these should be designed in a simpler way. We think the simplest way forward is for income tax relief to be only available in circumstances where the employee qualifies for a statutory redundancy payment. We also propose a government review of the existing exemptions, reliefs and reductions for termination payments, in order to establish in each case whether they should be retained as part of the wider reform of income tax and NICs treatment of termination payments.
Under this new relief, we propose that the level of the exemption would be a multiple of the statutory redundancy payment that the relevant individual is entitled to (or alternatively, a flat amount). All payments linked to the termination payment received by the relevant individual (including his/ her statutory redundancy payment) would be aggregated and then the income tax exemption would be applied against the value of these. Subject to this value limit, this relief could extend to any termination payments that he/ she receives – regardless of the nature of the payment.
The proposal would lead to simplification by making it easier to understand the circumstances to which the tax exemption applies (i.e. cases of statutory redundancy). Eligibility would not depend on the terms of the employment contract, as now, which favours the well-advised and can catch people out. Furthermore, there is a recognised statutory definition of redundancy, and a case to suggest that a common approach between employment and tax law is sensible.
But does this really make the tax treatment of settlement payments easier to understand and apply and any fairer?