The Government has announced the outcome of their consultation over the tax treatment of Settlement Agreements. The outcome is NOT the abolishment of the £30k exemption under S401-403 Income Tax (Earnings and Pensions) Act as many had feared, however there are some important changes now due to come into force by April 2018.
The main change is to dispense with the distinction between contractual and non contractual Pay in Lieu of Notice. Currently if the employment contract does not contain a contractual clause entitling the employer to make payment in lieu of notice the HMRC can not readily imply that a payment which is non contractual is taxable. This is to change and therefore whether or not there is such a clause in the future, subject to these amendments coming into force in April 2018, HMRC will be able to treat all such payment which appear to be for notice entitlement, as taxable.
Another important change relates to the National Insurance contributions payable on termination payments. Employer's NIC will now be payable on all sums paid over 30k from April 2018 after these changes have come into force.
The tax exemption for employees who have worked outside the UK for long periods (previously enjoyed under Foreign Service Relief) is to be removed from April 2018.
The existing exemption for death , disability and injury is to remain, however it is to be clarified that such exemption does not apply to injury to feelings
Settlement agreements are used in many cases as a way to resolve termination of employment issues without the parties needing to go through the Tribunal to reach an outcome or negotiate through ACAS to reach a conciliated settlement.
They have always been designed to attract the parties into negotiating the settlement of claims and the severance payments.
The changes will have an effect on the tax efficiency that can be achieved through these types of agreement, but they will still be a very popular way of parties coming to an agreement when negotiating exits and settling claims.
Following the budget announcement and consultation on proposals to reform taxation of termination payments, the government has now issued its response and put out for consultation detailed proposals on changes to taxation of termination payments. Under these proposals, the £30,000 tax exemption for termination payments would remain, but both contractual and non-contractual payments in lieu of notice would be fully taxable. Technical changes would be made to align the treatment of tax and national insurance contributions, and payments for injury to feelings (short of personal injury) would not come under the exemption for payments made on account of injury. The proposals are out for consultation until 5 October 2016, with the expectation that any changes will come into effect from April 2018.