Question

A partner of your accountancy firm has requested you to prepare detailed notes on the impact of redundancy pay. During this brief meeting with you, the partner said the following, “When the employment ofan employee ends prematurely (i.e. before reaching the retirement age or by resignation ofthe employee), it is called termination of the employment. Ordinarily this type of termination is initiated by the employer, therefore, breaching the employment contract between themselves and the employee. As a result, employers usually offer the employee some benefits at the time of termination to settle the breach of employment contract.”

The partner required you prepare a note that discusses the taxation of various benefits provided to the employees when their employment contract is terminated. Specifically, the following benefits must be separately discussed among any other benefits that you may come across in your research.

Gardening leave

Payment for training and skill development of employee

Past due salary & bonus

Pay in lieu of unutilised holidays

Payment in lieu of notice (PILON)

Statutory redundancy pay up to £30,000

Statutory redundancy pay above £30,000T

he discussion should also include how to determine whether benefits are being paid as ‘services rendered under employment’ or ‘as compensation for breach of the employment contract’.

References to the relevant sections of the legislation (section 62 & sections 401-416 ITEPA 2003) will enable you to secure higher marks.

REQUIRED:Present your detailed notes in a report format.

Your summary shouldbe detailed enough to be a basis for the partner to explain the matter to his clients. It may contain examples if that will improve the clarity of your report

Answer 1

When the employment ofan employee ends prematurely (i.e. before reaching the retirement age or by resignation ofthe employee), it is called termination of the employment. Ordinarily this type of termination is initiated by the employer, therefore, breaching the employment contract between themselves and the employee. As a result, employers usually offer the employee some benefits at the time of termination to settle the breach of employment contract.”

Statutory redundancy pay is calculated as the total of:

• for each complete year of service where age during year less than 22, ½ a week’s pay
• for each complete year of service where age during year is between 22 and 40, 1 week’s pay
• for each complete year of service where age during year is 41+, 1½ week’s pay

Termination payments and benefits are chargeable to income tax as general earnings and do not benefit from the £30,000 threshold available in section 403 ITEPA 2003.

EIM13874 defines the term ‘relevant termination awards’ and explains that relevant termination awards are split into 2 elements:

• post-employment notice pay (PENP)
• termination awards subject to section 403 ITEPA 2003

Statutory redundancy payments and approved contractual payments (as defined at section 309(4)-(6) ITEPA 2003) are not within the definition of ‘relevant termination awards’ (see EIM13874) and so are not subject to PENP. These payments are always chargeable to income tax as specific employment income and benefit from the £30,000 threshold available in section 403 ITEPA 2003.

A statutory redundancy payment made under:

• the Employment Rights Act 1996, or
• the Employment Rights (Northern Ireland) Order 1996

is exempt from liability to tax as earnings, within the definition given by section 62 ITEPA 2003 but falls within section 401 ITEPA 2003 as specific employment income.

In practice there’s unlikely to be tax payable under section 401 ITEPA 2003 because most statutory payments are less than the £30,000 threshold. However all payments in respect of a termination, excluding post-employment notice pay must be added together in applying that threshold.

Sometimes it is difficult to decide whether a payment provided for in a contract is in fact compensation for loss of employment by reason of redundancy. For example, a contractual term might provide for payment of a sum to an employee on termination “for any reason”. If a redundancy takes place, it might be argued that the payment has that character. But tax cases such as Dale v De Soissons (32TC118) have established that such a payment is essentially earnings deferred until termination, rather than compensation for loss of the employment. Redundancy may have triggered the payment, but any type of termination would have done so and the character of the payment remains the same whatever the trigger is. As earnings, it is taxable under section 62 ITEPA 2003.

If by contrast the contractual terms specify redundancy, then for the avoidance of doubt it may be accepted that the intention is to pay compensation for loss of employment by reason of redundancy. For example, if the contract says that a payment is to be made on termination “for any reason (including redundancy)” then it may be interpreted as providing such compensation (provided of course that there is in fact a redundancy within EIM13800). But as stated, this only applies to compensation for loss of employment; if the payment compensates for lack of due notice it does not have that character.

Payments made under contractual terms (which may be taxable as earnings) should not be confused with approved contractual payments (which are always chargeable to income tax as specific employment income and benefit from the £30,000 threshold available in section 403 ITEPA 2003).

Approved contractual payments has a specific definition at section 309(4)-(6) ITEPA 2003.