Clarifying taxation rules for UK termination payments Clarifying taxation rules for UK termination payments

Clarifying taxation rules for UK termination payments
31 Aug 2015

Last year the Organisation for Economic Cooperation and Development (OECD) issued an update to the Model Tax Convention that includes new commentary on the cross-border tax treatment of termination payments in an attempt to clarify how these payments should be taxed, including which country has the taxing right in cross boarder situations. But has anything changed here in the UK?

Not yet. But the OTS issued its comments in August 2014 and government have been known to listen to suggestions from the OTS - so watch this space.

In the meantime the current rules apply. Here is a recap on staging payments and the timing of the tax charge, plus the reporting obligations.

Key points to consider

• The taxation of termination payments is complex and case law can be contradictory
• The first £30,000 of a termination payment is not necessarily tax free
• Section 401 ITEPA charges to income tax payments and other benefits received
directly or indirectly in consideration, or in consequence of, or otherwise in connection with the termination of a person’s
• Payments made in respect of discrimination claims need careful consideration and thought must be given to whether the discrimination claim payment is linked to the termination or can it be apportioned to discrimination occurring prior to the termination
• Check when tax is due
• Make sure you report payments over £30,000 to HMRC by 6 July
• The UK government is considering, following the OTS report how to simplify the taxation of termination payments, but no changes as yet.

Lump sum or staged payments?

Most termination payments are paid as a lump sum with benefits in kind being provided for a certain period after termination. However, there are occasion when this is not the case.

Employers sometimes prefer to make the payment in stages. Whichever approach is chosen it is the nature of the payment that determines the tax treatment.

For example, if a staged payment were made subject to compliance with certain posttermination restrictions this payment would be taxable and liable to NIC, as it would be deemed to be contractual.

With staged payments you do also need to consider the timing of the tax (and or NIC) liability as this may impact the total amount payable.

Timing of tax liability: receipts basis

A cash termination payment is taxable when it is ‘received’. This is deemed to be the earliest of when one of the following occurs:
• Payment of the cash is made
• A payment on account of the cash is made
• The recipient can require it to be paid
• The recipient can require the payer to make a payment on account.
The HMRC manual at EIM13110 confirms that this it is open to the parties to agree the arrangements.

For non-cash benefits they will be taxable in the year in which the benefit is used or enjoyed (transferred). The problem with any non-cash benefits provided for a period of longer than two years from the date of termination is that they may result in a tax charge under the disguised remuneration rules in section 554D of ITEPA 2003.

If these rules kick in it means is that the value is treated as employment income for the relevant tax year and the employer must withhold tax and account for NICs through PAYE (even if the assets are not readily convertible assets). If there is a charge under the disguised remuneration rules, the £30,000 exemption does not apply.

Reporting to HMRC

Where the value of the settlement is more than £30,000, a formal report needs to be filed with HMRC by 6 July following the tax year in which the termination took place. There is no set format but a letter should be sent to HMRC with the termination details (where they have no already been reported say via the payroll under RTI).

There is no prescribed form, but the report should include:
• An estimated total value of package
• Details of cash payments to be made in the year of termination
• Details of cash equivalent of non-cash benefits to be provided in the year of termination

• An estimate of cash payments to be made after the year of termination
• The nature of benefits to be provided after the year of termination, and the terms on which they will be provided.
Where there is a cash-only settlement and no tax is deducted because the amount does not exceed £30,000, no report to HMRC is required.

Any material increases in the package must also be reported in writing. A material increase is one of £10,000 or more or an increase that takes the value over £30,000. 

• See Employer Further Guide to PAYE and NICs CWG2 2015-2016.

Susan Ball is head of the employment advisory team at Crowe Clark Whitehill, a leading national audit, tax and advisory firm.

 

Last year the Organisation for Economic Cooperation and Development (OECD) issued an update to the Model Tax Convention that includes new commentary on the cross-border tax treatment of termination payments in an attempt to clarify how these payments should be taxed, including which country has the taxing right in cross boarder situations. But has anything changed here in the UK?

Not yet. But the OTS issued its comments in August 2014 and government have been known to listen to suggestions from the OTS - so watch this space.

In the meantime the current rules apply. Here is a recap on staging payments and the timing of the tax charge, plus the reporting obligations.

Key points to consider

• The taxation of termination payments is complex and case law can be contradictory
• The first £30,000 of a termination payment is not necessarily tax free
• Section 401 ITEPA charges to income tax payments and other benefits received
directly or indirectly in consideration, or in consequence of, or otherwise in connection with the termination of a person’s
• Payments made in respect of discrimination claims need careful consideration and thought must be given to whether the discrimination claim payment is linked to the termination or can it be apportioned to discrimination occurring prior to the termination
• Check when tax is due
• Make sure you report payments over £30,000 to HMRC by 6 July
• The UK government is considering, following the OTS report how to simplify the taxation of termination payments, but no changes as yet.

Lump sum or staged payments?

Most termination payments are paid as a lump sum with benefits in kind being provided for a certain period after termination. However, there are occasion when this is not the case.

Employers sometimes prefer to make the payment in stages. Whichever approach is chosen it is the nature of the payment that determines the tax treatment.

For example, if a staged payment were made subject to compliance with certain posttermination restrictions this payment would be taxable and liable to NIC, as it would be deemed to be contractual.

With staged payments you do also need to consider the timing of the tax (and or NIC) liability as this may impact the total amount payable.

Timing of tax liability: receipts basis

A cash termination payment is taxable when it is ‘received’. This is deemed to be the earliest of when one of the following occurs:
• Payment of the cash is made
• A payment on account of the cash is made
• The recipient can require it to be paid
• The recipient can require the payer to make a payment on account.
The HMRC manual at EIM13110 confirms that this it is open to the parties to agree the arrangements.

For non-cash benefits they will be taxable in the year in which the benefit is used or enjoyed (transferred). The problem with any non-cash benefits provided for a period of longer than two years from the date of termination is that they may result in a tax charge under the disguised remuneration rules in section 554D of ITEPA 2003.

If these rules kick in it means is that the value is treated as employment income for the relevant tax year and the employer must withhold tax and account for NICs through PAYE (even if the assets are not readily convertible assets). If there is a charge under the disguised remuneration rules, the £30,000 exemption does not apply.

Reporting to HMRC

Where the value of the settlement is more than £30,000, a formal report needs to be filed with HMRC by 6 July following the tax year in which the termination took place. There is no set format but a letter should be sent to HMRC with the termination details (where they have no already been reported say via the payroll under RTI).

There is no prescribed form, but the report should include:
• An estimated total value of package
• Details of cash payments to be made in the year of termination
• Details of cash equivalent of non-cash benefits to be provided in the year of termination

• An estimate of cash payments to be made after the year of termination
• The nature of benefits to be provided after the year of termination, and the terms on which they will be provided.
Where there is a cash-only settlement and no tax is deducted because the amount does not exceed £30,000, no report to HMRC is required.

Any material increases in the package must also be reported in writing. A material increase is one of £10,000 or more or an increase that takes the value over £30,000. 

• See Employer Further Guide to PAYE and NICs CWG2 2015-2016.

Susan Ball is head of the employment advisory team at Crowe Clark Whitehill, a leading national audit, tax and advisory firm.