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The OTS summary relating to termination payments recommendations is detailed below.
This is an area which gives rise to confusion because many people believe that the first £30,000 of any ‘payoff’ will be tax-free and are faced with an unpleasant surprise when they find that is not the case. Furthermore, many employers are unclear about which parts of a termination package qualify for the exemption. The result can be that the well-advised benefit from the exemption; those without proper advice frequently trip up.
We believe that payments made in connection with a termination of employment should remain subject to income tax in principle, that certain exemptions should apply, but that these should be designed in a simpler way. We think the simplest way forward is for income tax relief to be only available in circumstances where the employee qualifies for a statutory redundancy payment. We also propose a government review of the existing exemptions, reliefs and reductions for termination payments, in order to establish in each case whether they should be retained as part of the wider reform of income tax and NICs treatment of termination payments. Under this new relief, we propose that the level of the exemption would be a multiple of the statutory redundancy payment that the relevant individual is entitled to (or alternatively, a flat amount). All payments linked to the termination payment received by the relevant individual (including his/ her statutory redundancy payment) would be aggregated and then the income tax exemption would be applied against the value of these. Subject to this value limit, this relief could extend to any termination payments that he/ she receives – regardless of the nature of the payment.
The proposal would lead to simplification by making it easier to understand the circumstances to which the tax exemption applies (i.e. cases of statutory redundancy). Eligibility would not depend on the terms of the employment contract, as now, which favours the well-advised and can catch people out. Furthermore, there is a recognised statutory definition of redundancy, and a case to suggest that a common approach between employment and tax law is sensible. There is also a case for reforming the NICs rules around termination payments as part of wider NICs reforms. This could result in payments above the exempt threshold being subject to NICs. Reforms along the lines we have suggested will help some who lose their job yet find their termination payment is fully taxable; others may currently benefit from a tax-free amount yet do not qualify for statutory redundancy. If Ministers decide to pursue this route, which we believe will be simpler, more data on potential winners and losers will be needed.