Out-Law News 4 min. read

OTS proposes "radical" restriction of tax relief on termination payments to redundancy cases


The current tax exemption that applies to the first £30,000 of a payment made on termination of employment should be withdrawn and replaced with a new relief available in cases of statutory redundancy only, according to the Office of Tax Simplification (OTS).

The recommendation is the most radical of those made in the final report of the OTS on employee benefits and expenses, which looks at accommodation benefits, termination payments and a variety of smaller benefits. The UK Treasury is unlikely to respond to the report ahead of this year's Autumn Statement, which means that there would not be any time for any policy changes before the 2015 general election.

The report also recommended that termination payments be used as a "test bed" to see whether a proposed alignment of income tax and national insurance contributions (NICs) would work in practice. However employment tax expert Chris Thomas of Pinsent Masons, the law firm behind Out-Law.com, said that the suggestion was "likely to prove very unpopular with employers".

"Whilst it certainly has the merit of simplifying a complex area, it will also mean having to 'gross up' in more cases, and when combined with the proposal to align the income tax and NIC regime it will leave employers with a hefty employer NICs bill," he said.

"On a brighter note, however, where an employee is redundant there may be scope to exempt more of the payment; such as any contractual payment in lieu of notice (PILON), which would currently be taxable. Employers will also welcome the suggestion by the OTS that HMRC review and relax its rather controversial practices on 'autoPILONs' and payments to employees who are nearing retirement age," he said.

In its report, the OTS said that aligning the way in which NICs and income tax are calculated on termination payments would benefit the Exchequer, "particularly in relation to the additional employer NICs that would result". However, this would also have a "real cost impact" for employers and departing staff, it said. It also forecast some difficulties with aligning the two regimes as income tax is collected on a cumulative basis throughout the tax year while NICs are only calculated with reference to what is paid in any given pay period.

The report is the third and final one by the OTS as part of its review of the way that employee benefits and expenses are taxed, following a general report published last year and one on travel and subsistence benefits specifically, published in January. Its review was prompted by concerns about the "piecemeal" rules governing the tax treatment of different payments which have not always developed in line with current employment practices.

In its latest report, the OTS found that there was significant confusion around the existing tax relief on termination payments, with most people assuming that the first £30,000 of any 'payoff' was tax free while less well-advised workers were unlikely to know of or exercise their rights to a tax free payment. It has proposed replacing the existing relief with a new income tax relief, only available on statutory redundancy payments, which would be based on a multiple of the statutory redundancy payment due to the employee or alternatively a flat amount.

In the short term, the OTS has recommended that HMRC "revisit" its position on the circumstances in which an 'autoPILON', or non-contractual payment in lieu of notice, is considered to have been paid. As part of this, it should consider relaxing its requirements that a critical assessment needs to have been made in order for a non-contractual payment not to be caught by the regime, and therefore automatically taxable, the OTS said. HMRC should also clarify its guidance on which termination payments in cases of injury or disability be exempted from income tax, and review the way in which it currently deals with termination payments internally, it said.

On accommodation benefits, the OTS found that rules for exempting staff living in employer-provided accommodation because it was "customary" and for the better performance of their duties were not working well while the application of pre-1977 rules in certain 'grandfathered' cases caused anomalies. It recommended that the existing exemption be recast so that only accommodation that was "necessary for the job" was exempt, using open market value rental rates for the purposes of assessing the value of accommodation benefits; while the most basic accommodation should be taken out of the tax charge entirely, it said.

"Accommodation and terminations are difficult and sensitive areas of the tax system which we knew needed proper time to discuss and develop recommendations for simplification," said OTS director John Whiting. "Whilst we heard wide consensus on the need for reform, not least because the rules do not seem to have kept up with changes to working practices, finding a way forward has not been easy."

"Consequently we have suggested some short-term improvements but we really think these are areas for fuller study in the directions that we have signposted. We think these offer real scope for simpler rules and more certainty for all concerned but there is more work to be done on their impact," he said.

Meanwhile, the Treasury has begun a consultation exercise which it plans to use to inform work on a new set of travel and subsistence expenses rules. In its January report, the OTS said that the current regime was no longer fit for purpose due to changes in working practices, including the growth of the temporary labour market and increase in home working. In response, the government intends to draft a new set of rules "from first principles". However, this project would not be completed in the current parliament, it said.

In this first consultation, the government plans to explore the circumstances in which employers pay travel and subsistence expenses, whether tax relievable or not, and how tax policy influences these decisions. This consultation will run until 23 October and the government intends to respond as part of this year's Autumn Statement. A second stage, during which a working group will be established to draw up a new set of principles on which the new rules would be based, will then run until Spring 2015, it said.

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