The case was heard by the First Tier Tax Tribunal where Tottenham won the case. It does, however, highlight HMRC’s treatment of employment termination payment, and the problems which can arise.
Background to the “Tottenham termination” case
The Tottenham case originally arose in 2011, when two players transferred from Tottenham to Stoke City by mutual consent before their contracts had officially expired. Tottenham agreed to make a payment to each player as compensation for the agreed early termination of his contract. The first £30,000 paid to each was paid free of income tax, and the entire amount was paid free of national insurance contributions. The basis of this treatment was that the payments did not arise “from” the players’ employment with Tottenham, but were compensation payments made because their contracts had been broken.
HMRC disagreed with this treatment, and said the full amounts paid were subject to tax and national insurance contributions, on the basis that they had arisen from the players’ employment. The football club appealed to the First Tier Tax Tribunal. The primary motivation for the football club in taking the case to tribunal was the cost of the potential national insurance contributions on the entire amounts, rather than the cost of losing the tax exemption, which was restricted in any case to the first £30,000 of each payment.
Although this was a complex case, the tribunal found in favour of the club; it agreed that tax relief was available on the first £30,000 of each payment, and that no national insurance contributions were payable. This was on the basis that the tribunal concluded the payments to the players were made in return for the surrender of their rights under their employment contracts, and did not therefore flow “from” their employment.
This case highlights the importance of ensuring the different components of termination payments are fully considered, and the correct tax treatment is applied to each component.
Outlining the tax rules for employment termination payment
Legislation provides that when leaving an employment, the first £30,000 of any termination payment received by the employee may be paid without deduction of tax, and the entire amount may be paid free of both employers’ and employee’s national insurance contributions. However, the tax treatment depends on the circumstances of the settlement agreement and as can be seen from this case, it can be the case that income tax and national insurance contributions are payable in full on some or all of the total termination package. This can of course result in significant extra expense for employee and employer alike.
The tax treatment of an employment termination payment depends on what each part relates to, the contractual entitlement of the employee, and often on the employer’s usual conduct in such cases.
What payments are taxable?
Payments that the employee receives as part of their contractual entitlement are taxable. For example:
- Payment relating to outstanding salary entitlement
- Holiday pay
- Other employment related earnings e.g. bonus or commission
- Benefits in kind e.g. retaining a company car
- Any other payments made under the employment contract, e.g. payment in lieu of notice
- Pay received while on “garden leave”
What payments are not taxable?
Payments that are made as compensation for breaking the employment contract, and which do not flow from the employment, will generally be free of income tax up to the limit of £30,000, and totally free of national insurance contributions. For example:
- Statutory, contractual and ex gratia redundancy payments made on account of genuine redundancy
- Non-contractual ex gratia payments made as compensation for loss of employment, provided the employer does not have a history of offering similar payments, such that the employee might expect to receive such a payment
- Anticipated damages claims for unfair dismissal, or non-contractual pay in lieu of notice on wrongful dismissal
- Legal costs paid by an employer to the employee’s solicitor – provided they are wholly in respect of the settlement agreement and incurred solely in connection with the termination of the employee’s employment
New employment termination payment tax rules expected in April 2018
In the last Budget, the government pledged to “simplify” the rules surrounding employment termination payment, and launched a consultation process which closed recently. Although we are awaiting final outcomes, we expect the changes to be effective from 6 April 2018 and to include the following:
- Currently any contractual payments made in lieu of notice are taxable, whilst genuine non-contractual payments in lieu of notice are tax free. It is also necessary to look at payments customarily made by the employer to consider whether an expectation of payment in itself forms a contract. This distinction is to be withdrawn with all payments in lieu of notice to become fully taxable
- Any post-employment payments made (such as bonuses) are to be taxed
- The £30,000 exemption for income tax purposes will continue to apply to payments made over and above payments in lieu of notice and other taxable amounts
- Currently the proportion of any payment above £30,000 is subject to income tax only and is free of both employers’ and employee’s national insurance contributions. Whilst payments above £30,000 will also become chargeable to employers’ national insurance contributions, the entire amount will remain free of employee’s national insurance contributions
- Foreign service relief income tax exemptions will cease to apply