Simplification of the Tax and National Insurance Treatment of Termination Payments Response by the Chartered Institute of Taxation

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1 Simplification of the Tax and National Insurance Treatment of Termination Payments Response by the Chartered Institute of Taxation 1 Introduction 1.1 The Chartered Institute of Taxation (CIOT) sets out below its response to the 24 July 2015 consultation document on how to make the income tax and National Insurance treatment of termination payments simpler and fairer. 1.2 The government consultation follows a challenge laid down in the Office of Tax Simplification s (OTS) final report on employee benefits and expenses 1 which concluded that the current system for the taxation of termination payments caused confusion and uncertainty. 1.3 The CIOT is therefore pleased that the government has taken up the OTS s suggestion to consult on recasting the rules on termination payments. 1.4 However, our ability to make firm recommendations is constrained by a lack of understanding in terms of the government s underlying policy in this area (apart from the objective of simplification). In consequence, there are a number of different options that could be adopted which we have reflected in what follows. 2 Response to the consultation 2.1 We think that the present consultation presents an opportunity for simplification that should not be missed. Whole chapters have been written on the taxation of termination payments and there is now a chance to make a real difference. 1 Review of employee benefits and expenses: final report

2 2.2 Tax and NICs treatment of contractual and non-contractual payments (Q1 2 ) The distinction to be made is really between what constitutes earnings rather than compensation, as opposed to whether payments are contractual or non-contractual. For example a discretionary bonus is still earnings. Conversely, contractual redundancy payments are still compensatory. We think the difference between compensation and earnings is important throughout employment and not just on its termination, e.g. compensation payments made in relation to, say, discrimination, injury to feelings etc, would not normally be taxable earnings where an employment is ongoing, regardless of the amount of compensation, so it is difficult to see why compensation payments should be treated any differently if paid as part of a termination. 2.3 We understand that removing the distinction between earnings and compensation payments made on a termination would mean one less step when determining the tax analysis. This would, we agree, clearly simplify things. However there are number of consequences from this and other proposals taken together that would still need to be thought through. In particular, in circumstances where on a qualifying termination there will, instead, be an exempt amount to be applied against all types of payment in the termination bucket when calculating PAYE and NIC, i.e. including earnings that would otherwise be taxable. The question that then arises is what this will cost the Exchequer and whether the NIC savings from tax and NIC alignment (see paragraph 2.6 below) and the limiting of the exempt amount to qualifying terminations will be sufficient to balance the books. We have not looked at any figures on this but it seems to us that the NIC change in particular ought to bring in considerable revenue. 2.4 It is also worth recalling that the reason the exempt amount was originally introduced was to alleviate the hardship caused on the loss of employment, primarily by blue collar workers. Nothing has changed in this regard. Save for voluntary resignation and individual cases where an employee is fortunate enough to find new employment quickly, the loss of employment will almost always cause hardship for the employees and families impacted. The real value of the tax relief on 30,000 exemption has eroded considerably over time, but it is still a meaningful sum for those in the original target group, in proportion to their average earnings. We do not consider that this should be reduced; if anything, as noted in paragraph 2.9 below, we think that the revenue raised from tax and NIC alignment may present a case for increasing this limit, rather than simply applying the revenues raised against payments that would ordinarily be taxable. 2.5 (Q2) Some would say that the present issue around earnings versus compensation centres on arguments around non-contractual PILON versus contractual PILON versus auto-pilon and that if this was clarified the issue would go away. There is equally a view that the argument extends beyond this to custom and practice so that, in our view, it would be a good thing to end this sterile debate in toto by treating earnings and compensation payments alike. 2.6 Alignment of income tax and NICs treatment of termination payments (Q3-4) In terms of aligning the tax and NICs treatment of termination payments, the position would undoubtedly be simpler for employers, but clearly this would come at a cost to employers and employees. Accordingly, if this is to happen we think it is important that the amount of the exemption is set so as to fully take account of the increase in the NIC which the Exchequer would receive in these circumstances. And, as we have said above, we do not in any event think the exemption should fall below the present limit of 30, Question numbers refer to the questions raised in the consultation document P/tech/subsfinal/ET/2015 2

3 2.7 Options for reform of the tax and NICs exemption (Q7) We understand the Government s reasoning in considering linking an exemption for termination payments to redundancies falling within section 139 of the Employment Rights Act Although, in fact the proposals go wider than this in terms of preserving the exemption in cases of unfair/wrongful dismissal as well (see paragraph 2.19 below). The real question is whether employers will be clear on when the exempt amount applies and when it does not. We have to say that views genuinely differ on this point. Some would consider that as the employment law position already has to be considered on a termination, including whether or not a termination falls within the meaning of redundancy, then there should not be an issue. Others are less convinced and feel that employers may be confused on this point, particularly given that it s not just whether a termination is a redundancy but also whether unfair/wrongful dismissal is or may be involved. 2.8 At the same time clearly the exemption would no longer apply to ex gratia payments when someone voluntarily leaves employment. In other words (which employers will need to appreciate) where there is an amicable parting of the ways and a non-contractual thank you. We can see the logic of framing the new rules in this way but if this change is to be made then, as noted above, it will be important that the amount of the exemption is increased to fully take this on board. 2.9 (Q6) The Government propose a two year period of service before an employee could qualify for the exemption and then increasing the amount of the exemption for years served after this qualifying period. In terms of simplicity we think the simplest approach would be to provide for a single exempt amount regardless of length of service if the circumstances are such as to fall within the basic definition of a qualifying termination In terms of fairness, we think there is a principled argument to be made that losing a job after one year has the same effect as losing a job after 3 or 5 years, i.e. losing the means to earn a living. We understand from our meetings with HMRC and HMT, that this is now a broadly accepted view (Q5) In terms of the amount at which the exemption should be set then we think this should be such that the changes are tax/nics neutral to Government. In particular, we note that aligning the income tax/nics treatment would increase revenues, as would narrowing the circumstances in which the exemption would apply (e.g. by treating PILON and ex-gratia payments as taxable and addressing the tax treatment of payments made when a fixed term contract coming to a natural end). Accordingly, our sense would be that the basic exempt amount of 30,000, which has not changed since 1989, should be increased accordingly, albeit we think the numbers will need to be crunched to get to a final view on this Anti-avoidance provisions (Q9-10) The need to include targeted anti avoidance rules, for example to prevent salary being sacrificed in return for a higher tax-free termination payment, is understandable, but we do think that the approach needs to be measured on this. For example, where someone works on a fixed term contract but is made redundant before that contract ends then we see no reason why they should not benefit from the exemption in the same way as everyone else Similarly if someone is made redundant from an employment but sometime later and unforeseen at the time is re-engaged at a later date we do not see a blunt 12 month test as P/tech/subsfinal/ET/2015 3

4 the answer. Rather we think a better test would be around whether there were arrangements in place at the time the redundancy took place. This would protect those cases where the re-engagement was not in any sense pre-planned but where it just turns out that the business does need the individual s services at a point following the redundancy Exemptions which remove the liability to income tax (Q11, 13 & 15) We think that the current full exemptions for injury and disability payments on termination, HM Forces payments, legal fees and pension contributions should be retained under the new rules (Q12) We agree that the differentiation between contractual and non-contractual elements of an injury or disability termination should be removed. This simplification ties in to that proposed more generally under the new regime and to take a different approach would confuse matters (Q14) Where the termination payment includes an element for foreign service it is true that the current rules for calculating the exempt portion are complicated. That said, the current rules have applied for many years and build off those that also apply for lump sum payments on retirement and death at section 395B, ITEPA So it really comes down to what the government would propose instead? If this was in effect to apply the normal sourcing rules for earnings then although there may be a measure of simplification it would still seem necessary to look at the period over which the individual had been employed, where they were employed, etc. So we are not necessarily convinced that the current rules should be changed Having said this, consideration might be given to adopting the OECD model, and apportioning payments according to the last 12 months of employment, which would help to align the UK with many EU countries New Exemptions We have commented above about the proposal to link exemption to redundancy but we return to this point in the context of the specific questions around unfair/wrongful dismissal and (i) the financial cap that should apply and (ii) whether it should make a difference as to whether we are talking about an actual award of damages or amounts paid by the employer out of court (Q17) In principle, we think the exempt amount should be the same as would apply on other qualifying terminations (which are not fully exempt). Anything else would be likely to confuse and create uncertainty. Awards can be adjusted by a tribunal, or as part of a negotiated settlement, to take account of the income tax and NICs liabilities (Q18) We also think that it should make no difference as to whether the payment is a payment of damages awarded by a tribunal or an amount paid by the employer out of court. To favour awards made by a tribunal would seem only to encourage the parties to litigate with the time and costs (and, potentially, detrimental publicity) that that entails all round (Q19-20) Finally, similar issues arise in respect of cases of discrimination as have been made above in respect of unfair/wrongful dismissal. Consequently, we think the exempt amount should be the same as would apply on a redundancy and that it should make no difference as to whether the payment is tribunal awarded damages of an out of court settlement. P/tech/subsfinal/ET/2015 4

5 3 The Chartered Institute of Taxation 3.1 The Chartered Institute of Taxation (CIOT) is the leading professional body in the United Kingdom concerned solely with taxation. The CIOT is an educational charity, promoting education and study of the administration and practice of taxation. One of our key aims is to work for a better, more efficient, tax system for all affected by it taxpayers, their advisers and the authorities. The CIOT s work covers all aspects of taxation, including direct and indirect taxes and duties. Through our Low Incomes Tax Reform Group (LITRG), the CIOT has a particular focus on improving the tax system, including tax credits and benefits, for the unrepresented taxpayer. The CIOT draws on our members experience in private practice, commerce and industry, government and academia to improve tax administration and propose and explain how tax policy objectives can most effectively be achieved. We also link to, and draw on, similar leading professional tax bodies in other countries. The CIOT s comments and recommendations on tax issues are made in line with our charitable objectives: we are politically neutral in our work. The CIOT s 17,000 members have the practising title of Chartered Tax Adviser and the designatory letters CTA, to represent the leading tax qualification. The Chartered Institute of Taxation 23 October 215 P/tech/subsfinal/ET/2015 5