Termination Payments – Get The Tax Right

Having to make redundancies is never pleasant but the situation for an employer and employee can be made worse if tax matters with regard to any termination payment are not dealt with correctly: this is a particular risk where PAYE is not deducted when it should have been. If this occurs, the payment made is treated as a ‘net’ payment and is then grossed up for Income Tax (IT) and National Insurance Contributions (NICs), which adds more than a third to the cost of any payment.

The biggest risk for an employer in these circumstances is where the rules relating to a ‘golden handshake’ are breached. Normally, up to £30,000 can be paid free of tax to an employee being made redundant, without IT or NICs being payable. Strictly, this is because the payment is not arising from employment but is, in effect, in lieu of damages for loss of employment.

Normally, such payments are arranged by way of a compromise agreement, by which the employee agrees not to make a claim to the Employment Tribunal in exchange for a payment. The employee’s legal fees for advice can also normally be paid by the employer without a tax charge arising.

The important issue here is that the payment must not be contractual, as a payment of any sort under contract is taxable. A payment in lieu of notice, for example, is taxable, as it is a payment arising by virtue of the employee’s contractual right to salary during the notice period.

The material contained in this article is provided for general purposes only and does not constitute legal or other professional advice. Appropriate legal advice should be sought for specific circumstances and before action is taken.

© , October 2009

Please contact:

Emmanuelle Ries

DD +44 (0)20 7553 9938

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