UK Government Set to Overhaul Taxation on Termination Payments

August 19, 2016

Currently, non-contractual compensation payments made solely on account of termination of an individual’s employment enjoy a favourable tax treatment in two respects – the payment can be made without deduction of income tax up to £30,000 and no employee or employer national insurance contributions (NICs) are payable on the termination payment. Payments eligible for this tax treatment are to be distinguished from payments paid pursuant to the individual’s employment contract, such as bonuses and contractual payments in lieu of notice, the full amount of which are subject to income tax and employer and employee NICs.

Having previously indicated its intention to simplify and make fairer the rules surrounding the taxation of termination payments, the Government has now published a new consultation setting out the conclusions of its earlier consultation in July 2015 as well as draft legislation to implement its proposed changes to the rules on termination payments located in the Income Tax (Earnings and Pensions) Act 2003. Subject to further comments from stakeholders on the new consultation (which is open for comment until 5 October 2016), the proposed changes to the relevant tax rules are due to take effect in April 2018.

Whilst the consultation considered increasing or decreasing the £30,000 tax exemption threshold on termination payments, the proposal is to preserve the existing threshold but to clarify the position in relation to NICs and payments referable to an employee’s notice period.

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