Taxation of termination payments
A payment to any director or to an employee when their period of office or employment ends is taxable on general principles if it is a reward for services.
If a payment is made to compensate an employee for loss of rights in respect of their employment, the position is more complicated.
Statutory redundancy payments.
Outplacement counselling and related fees or travelling expenses
Genuine non-statutory redundancy payments, even if they form part of the employee’s contract of employment.
Payments in lieu of notice (PILONs)
These are taxable as normal where the employee has been paid a lump sum, but has not worked after giving notice. For example, where an employee is on ‘gardening leave’ prior to joining a competitor. Normal taxation also applies where the employee’s contract provides for PILON to be paid as an alternative to notice.
Charge under Section 403 ITEPA 2003
- Employer and employee agree at the time of termination that the employment is to be terminated without proper notice, but on making a PILON
- Contract does not provide for a PILON, the employer terminates the contract and offers a PILON.
Section 403 exempts the first £30,000 of payments made in respect of termination in the relevant tax year.
The £30,000 threshold applies in respect of:
- the same employment;
- different employments with the same employer
- employments with employers who are associated
Contributions to approved personal pension schemes
Death or disability payments or benefits
Payments and benefits under tax-exempt schemes
Contributions to registered pension schemes.
Partial or full exemption for overseas service under Sections 413 and 414 ITEPA 2003
Funded unapproved benefit schemes (FURBS)
Unapproved schemes are often used to top up benefits arising under an approved pension scheme. If an employer sponsors a payment to such scheme in advance of any payout, it becomes a funded unapproved benefit scheme (FURBS). Any benefit is chargeable on the cash or cash equivalent of the payment or benefit.
Non-cash benefits are valued in accordance with the benefit in kind rules for earnings.
Ex gratia lump sums
Most ex gratia payments are charged under normal principles, subject to Section 403 ITEPA, as above.
They may, however be taxed as FURBS where the payment is made under ‘an arrangement’.