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Termination payments – is complexity a price worth paying?

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As tax advisers, we rightly pride ourselves on our knowledge of the UK tax system. But we also know that when it comes to real knowledge you just can’t beat the “man in the pub”. All of us had have had experience of being told that our advice is wrong because the “man in the pub” says something different. 

Termination payments are a case in point. The man in the pub knows that “the first £30,000 of any pay-off when leaving a job is tax free”. If only it were as simple as that.

Certainly some termination payments do qualify for the tax exemption but there are many that don’t, and structuring such payments to ensure that the maximum tax relief is available can be difficult – particularly when what works best for tax purposes creates significant employment law issues. 

The Office of Tax Simplification (OTS) has been looking at this and has come up with a solution. But while it’s certainly a simplification it would, if implemented, be very unpopular.

Essentially it is proposing that where there is a genuine redundancy – i.e. one where the individual would qualify for statutory redundancy pay – all payments up to a limit would be tax free regardless of how they were described. The OTS doesn’t specify a limit, but suggests that it could either be a fixed sum or a multiple of statutory redundancy pay. So far so good. 

But the sting in the tail is that where a payment wasn’t associated with a genuine redundancy, no relief would be available and the whole of the payment would be taxable.

One can see the logic in this, but it would be a considerable departure from what currently happens in practice. 

The existence of the £30,000 exemption certainly makes it easier for employer and employee to negotiate an amicable parting of the ways. The employee gets tax-free cash to tide them over until the next job, and the employer doesn’t have to go through the formalities of a redundancy or disciplinary process. Indeed, such settlements have recently been approved under the Employment Rights Act.

The OTS proposals are currently out for comment and we don’t know whether the government will proceed with the idea. 

But what this shows, yet again, is that tax simplification in itself isn’t always the best option. Sometimes a more complex tax system is a price worth paying for commercial flexibility.

Andrew Hubbard is a tax partner at Baker Tilly.

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