I know that over the years we have said some pretty harsh things in this blog about assorted government proposals and consultation exercises, but I take it all back. There is a new kid in town, the HM Treasury/HMRC consultation document on Simplification of the Tax and National Insurance Treatment of Termination Payments https://www.gov.uk/government/consultations/simplification-of-the-tax-and-national-insurance-treatment-of-termination-payments and to say that this appears grossly under-thought just doesn’t capture it, somehow.
The stated aim of the exercise is to make the tax and NI treatment of termination payments “simpler and fairer”. It does neither. On its face the paper represents instead a naked attempt to bring more money into the Treasury regardless of the level of disadvantage and cost which that entails for both employers and employees.
Let us deal with the fairness point first. Ultimately this boils down (paragraphs 2.5 and 3.5) to the suggestion that richer people can pay for better advice about maximising their tax position. That has always been true, will always be true (tax avoidance has been around as long as tax itself) and appears not to concern HMRC in relation to any other single aspect of the UK tax regime. However, the solution proposed on the employment front is the introduction of changes whose principal adverse impact will be on the less well off.
As to simplification, the consultation document refers repeatedly to “complexities” in the current system. Again, on closer reading this is primarily confusion over the tax treatment of pay in lieu of notice. This is a confusion largely generated by HMRC itself through its “auto-PILON” concept blurring the otherwise relatively clear line between contractual and non-contractual. The proposed solution to this is to tax both. Simple, yes. Fair? Not necessarily. Confused in its conception? Certainly – paragraph 3.2 refers in shocked tones to “cases where employees and employers argue that a payment in lieu of notice is actually a payment for breach of contract” – but it is, unless provided for by contract. This particular problem is compounded by the express view that pay in lieu of notice should be taxable while damages for wrongful dismissal (i.e. failure to give proper notice) should not, even though they are in fact the same thing. The need to distinguish between contractual and non-contractual arises in many contexts in the employment relationship, and there is no real case (apart from HMRC’s self-interest) for suggesting that it is particularly problematical on terminations.
So far so simplified, but then in ride the proposed replacement tax exemptions. To remove complexity, one would assume a blanket easily-understood number, tax-free below and taxable above, whatever the reason for the termination. What we have instead is an allowance which:
- increases with length of service;
- is only payable on termination by reason of redundancy; and
- applies only if you have more than two years’ service.
The figure is proposed to be £6,000 after two years’ service, increasing by £1,000 per year thereafter seemingly without upper limit. An example is provided: Pat is made redundant after 10 years. He gets £13,750 made up of notice pay, ex gratia, statutory redundancy pay and holiday pay. The length of service formula gives him a £14,000 tax exemption so he gets the lot tax free, including the holiday pay which would currently be taxable. So the taxable status of one’s accrued holiday pay would depend under this new system on:
- your length of service;
- what other payments were made in connection with the termination, whether or not at the same time; and
- whether you are redundant or not within the statutory definition.
Simplified, you say?
The limiting of the tax exemption to circumstances of statutory redundancy seems particularly misguided. There is a thinly-disguised moral driver to this, in that paragraph 4.23 refers to the government’s wish to “support those who lose their employment through no fault of their own”. This obviously overlooks the numerous other no-fault reasons besides redundancy for which employees can lose their job – incapability, illness, SOSR/restructure or in some cases, illegality. In addition, the exemption will also cover voluntary redundancy, a circumstance in which it is the employee’s own actions which cause the employment to end. What this will generate is obviously a pressure on employers even greater than exists already to describe as redundancy circumstances which are not – poor performance, sickness, etc. It will also mean that employers strong enough to resist that pressure will automatically find settlements far harder to reach, causing both parties additional stress and cost. Who could blame them if the point were then “fudged”? What qualifies HMRC to determine, perhaps years later, whether a particular termination fell within or without that statutory definition is unclear. How far would the employer have to go to demonstrate its thinking at the time, its business plans, its pooling and selection processes in relation to each individual?
At paragraphs 4.39/40, the government thinks that there is a strong case for exempting from tax those payments made “in connection with compensation for unfair or wrongful dismissal”. We have to assume that very few employers pay termination compensation wholly without regard to buying out some actual or anticipated unfair dismissal claim, hence the usual requirement of a settlement agreement in return. On that basis, it would appear that if I pay my employee any compensation figure up to the unfair dismissal maximum, he can have both that and his notice pay tax-free, even though this might far exceed the length of service formula and even though this flatly contradicts the consultation paper’s stated position that pay in lieu should be taxable. You presume that this is not the intention, but it is what is says.
Paragraph 4.26 of the paper suggests that severance payments would become taxable if the employee were re-engaged to do a similar job for the same company or an associated company within twelve months from his redundancy. This is clearly aimed at public irritation over senior civil servants leaving with big payments and then being rehired, but it equally clearly misses that target by miles. The employee still gets the big severance payment disproportionate to his actual losses, but now at least HMRC gets something out of it too. This also means that neither employee nor employer actually knows the final tax status of the severance payment for a full year post-termination. That twelve month shadow (seemingly applied even though the employee’s losses in that year may far have exceeded the severance payment, such that he makes no “windfall” at all) is totally incompatible with the Government’s wish (paragraph 3.2) that “people should have certainty that they have paid the correct amount of tax when they leave a job”.
However, the crowning failure of these proposals is the suggestion that any money awarded by an Employment Tribunal in respect of discrimination would be tax-free, seemingly without limit. Nothing is said about the tax treatment of awards or settlements for other alleged wrongs, such as detriment or whistleblowing, or whether this would depend on the employee having 2 years’ service. Nor is there any rationale put forward for distinguishing between compensation for loss caused by unfair dismissal (which the parties appear to be able to settle without a tax charge) and that caused by discrimination (which they can’t). In other words, while employee and employer may be willing to settle a discrimination claim, some or all of the sum will be taxable unless they first go to all the trouble, expense and drain on the Tribunal system of fighting it. Simple? Fair?
The only single glimmer of good news in this is the proposed abolition of foreign service relief which is indeed complicated, applies to very few terminations and would be no real loss to the statute books. However, without wishing to criticise for the sake of it, the rest of this paper reads as a series of ill-considered, disjointed and mutually inconsistent proposals based on a depressingly limited understanding of both law and employment practice. Both employers and employees are entitled to expect better than this.