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The changes to tax treatment of termination payments

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From 6th April 2018, new rules on how termination payments are to be treated with regards to tax came into force.  These new rules have tightened the tax treatment of payments made, whether these are made within a settlement agreement or not.  Some of the most common have been highlighted below but obtaining advice in respect of termination payments should be taken to ensure the tax treatment is applied correctly.

Where such payments are made, it is now important to assess the basis on which the payments are made and the factual background in order to assess whether tax is payable or not.  The statute applicable in relation to this matter is the Income Tax (Earnings and Pensions) Act 2003 (ITEPA).

HMRC recommends that the following questions be addressed, in the following order:

  1. Does the payment fall within the category of general earnings (or is it a benefit of the employment) under Parts 2 to 5 of ITEPA 2003?
  2. If not, is the payment for a restrictive covenant taxable under 225& 226 of ITEPA 2003?
  3. If not, and no other income tax charge applies (for example, compensation for loss of a share option), is the payment taxable under s. 401- 416  of ITEPA 2003?

This follows the order of priority in which the statutory provisions are applied.

Sections 401 – 416 of ITEPA 2003 act as charging provisions for termination payments where no other charging provision applies. As a result, they will only apply if the payments are not otherwise taxable under s. 62 of ITEPA 2003 or any other provision such as those above.  It covers payments and other benefits received in connection with the termination of employment or a variation in the duties or earnings from employment.

  1. 401 is widely drafted and is designed to catch all payments and benefits that are not earnings. Therefore, rarely will ex gratiapayments (in excess of £30,000) escape liability to taxation altogether. The first £30,000 of payments that fall within section 401 and is not treated as “post-employment notice pay” (PENP) is exempt from tax and any excess will be subject to income tax in the normal way.

NIC’s

NICs are generally payable in respect of all termination payments to which the employee is entitled under the contract of employment. HMRC may also argue that NICs are payable where there is an automatic practice of making termination payments, even where there is no express contractual right.

Payments within s. 401 – 416 of ITEPA 2003 are not “earnings” for NICs purposes and are therefore not generally liable to NICs, but may be brought into charge by express provisions.

The different types of payments

HMRC continues to scrutinise carefully payments made on the termination of employment where s. 401 – 416 of ITEPA 2003 are being relied on. Careful analysis of the nature of a termination payment is crucial therefore, as this will determine its tax treatment.

Contractual severance payments (other than payments in lieu)

Most contractual payments are liable to income tax under s.62 of ITEPA 2003 and to NICs. This is the case even if the payment is intended to compensate for loss of future earnings.

HMRC also treats payments made on termination as subject to tax under section 62 of ITEPA 2003 if there is an established custom of making these payments.

Benefits in kind

Severance packages often include benefits in kind, such as a company car. Other than specific exclusions such as outplacement costs, the benefits are valued in the same way as benefits provided during. Non-cash benefits will be valued at an amount equal to the cash equivalent of the benefit.

Share options and share awards

Employees may be entitled to exercise share options and/or receive share awards either before or at some point after termination.  The terms of the relevant employee share scheme will govern any right of exercise or entitlement to receive shares. Therefore, the reason for the termination will need to be clearly identified for the purposes of dealing correctly with the employee’s share scheme entitlements.  However, there are many factors which need careful consideration as in relation to shares so individual advice on this is crucial.

Payments in lieu of notice from April 2018

From 6 April 2018, all payments in lieu of notice (PILON) paid on termination of employment will be classed as earnings. Payments will therefore be subject to tax and class 1 NICs.  The tax treatment no longer depends on whether there is a contractual PILON in the contract of employment or not and settlement agreements will clearly need to show which portion of the payment is a PILON.

What is a relevant termination award?

A relevant termination award (RTA) is a termination award excluding specified payments.

A termination award is defined as a payment or other benefit received directly or indirectly in consideration of in consequence of or otherwise in connection with the termination of a person’s employment.  Accordingly, payments or other benefits chargeable to tax apart (such as restrictive covenants and contractual PILONs for example) are not termination awards.

The excluded payments are statutory redundancy pay and approved contractual pay (to the extent that it does not exceed the statutory redundancy pay).   So, these automatically benefit from the £30,000 exemption.

This means that non-statutory redundancy pay is a termination award and, in contrast with statutory redundancy pay is not excluded.

Therefore, non-statutory redundancy is a “relevant termination award” and will no longer automatically fall within the £30,000 exemption.

What must be taxed as earnings?

The slice of the relevant termination award (RTA) that must be treated as earnings under s. 402B is:

  • The entire RTA if “post-employment notice pay” (PENP) is equal to or more than the RTA.
  • PENP, if it is less than the RTA but is not nil.

If PENP is a negative amount, it is treated as nil.

Pay in Lieu of Notice (PILON)

There are a number of different types of PILON’s used and, for the most part, HMRC will consider them all as taxable.  Indeed, there is numerous case law just on this topic.  Certainly contractual and implied PILON’s are usually taxable but PILON’s paid as damages for loss of notice may fall within s. 401 of ITEPA 2003 and can therefore be paid tax free (up to the £30,000 limit).   However, HMRC will look carefully at the reason for the PILON payment to ensure it falls within the definition of damages rather than another sort of PILON so a careful analysis of this is important.  Advice should be taken in each circumstance.

Redundancy

Statutory and enhanced redundancy payments fall within s. 401-416 of ITEPA 2003, provided they are paid genuinely on account of redundancy. No NICs are payable.

Payments which are, in fact, a terminal bonus paid in recognition of an employee’s services during the notice period or during the employment generally will be taxable s. 62 and subject to NICs.

The employer should take care if the employee is retiring, or where some of the redundancy payment will be conditional on staying until a specified date, because HMRC could seek to tax such payments as employment income.

New PENP rules from 6 April 2018

As noted above, statutory redundancy pay and approved contractual pay (to the extent that it does not exceed statutory redundancy pay) automatically benefit from the £30,000 exemption.

Non-statutory redundancy will no longer automatically fall within the £30,000 exemption.

For any queries in relation to the above, or termination payments generally, please contact Ilinca Mardarescu.

Boomerang Kids, Transfer of Equity and Tax

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Your kids have fled the nest to attend University – to study and get a “good job”. Then, they graduate, but have been struggling to get the job they hoped for and subsequently they return home, unable to take that first step onto the property ladder. This move back home can be very stressful for both children and parents, especially when lifestyles have adapted to the new environment.

You decide you would like to do something to help your child, but all your assets are tied up in your property. Someone mentions a “Transfer of Equity”, whereby you could transfer some or all of the property’s assets to your children and that way, they would have something of their own.

In this case, there are a few matters you need to consider: firstly, the Tax implication of making the Transfer; and secondly, whether your child would be able to draw up a second charge on your property in order to purchase another of their own. Assuming your child is able to obtain the finance for their new property, have you considered what would happen should your child be unable to repay the 2nd charge on your family home? In addition, have you considered the Tax implications? At the very least, there are possible Inheritance Tax implications for you transferring a share of your family home to your children as well Stamp Duty Land Tax considerations for your children as they will be deemed to own two properties.  What if your child becomes bankrupt in the future? The share of your property which they own would automatically form part of their estate and it would be for the trustee in bankruptcy to distribute, along with anything else your child owns, in accordance with their duties.

All of the above factors, and more, need to be considered. This has become an increasingly common situation in today’s property market and we work together with our clients, tailoring our services to their individual needs. If this has raised any queries concerning your personal situation in relation to a potential transfer of a property, Inheritance Tax, Trusts, or you simply find yourself in a position to purchase your first property – we are here to help!

Nicola Darby

Conveyancing Secretary

Squatting: What you need to know about Adverse Possession

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Adverse Possession is more legally the term to describe ‘squatting’. Therefore, it is the process of a person who is not the legal owner of the land but who can then become the legal owner, if they have been in possession of the land for a certain period of time and if they have met the criteria below. The rules have somewhat changed since the introduction of the Land Registry Act 2002, however, the principles remain the same.

Limitation

  • The Land Registration Act 2002(LRA 2002), which came into force on 13 October 2003, introduced a new regime which applies to claims for adverse possession of ‘registered land’ where 12 years’ adverse possession had not accrued before 13 October 2003. Therefore, the new rules require 10 years adverse possession of the land before an application can be made.
  • The old law continues to apply to adverse possession in respect of ‘unregistered land’ (based on 12 years’ adverse possession under the Limitation Act 1980(LA 1980)) and registered land where 12 years’ adverse possession had accrued before 13 October 2003 (under transitional provisions of the LRA 2002).

Criteria

  1. Factual Possession of the Land – You will need to demonstrate sufficient degree of ‘exclusive physical control’. This is dependent on the use of the land; it may be sufficient grounds to mow the grass, plant flowers, and place signposts up for advertising. A major point that must be considered is that when you are exercising the said factual possession, you are in essence excluding the world at large when doing so. It is usual for someone to fence land off/erect locked gates in this regard; though this is not always determinative it can be exceptionally helpful.
  1. Intention to Possess – You need to establish for the last 10 or 12 years that it has always been the intention to possess the land exclusively.
  1. Occupation without the Owners Consent – Consent can be either formal or informal, for instance a license to occupy or a conversation confirming your use of the land.

If the above criteria are met, then you will be in a position to make an application to the Land Registry. In support of your application for adverse possession you will need to provide supporting historic evidence in the form of a statutory declaration, stating the circumstances of your occupation.

If you are considering making an application for adverse possession, contact our experienced litigation department today. Our dynamic team think outside the box to assist you in finding the best solution based on your needs and circumstances.

An AI Just Defeated a Group of Lawyers

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AI has taken a big swing at chess players, poker players, go players and now lawyers! A showdown between some of the best lawyers in the world and an AI intelligence platform LawGeex, over an interpretation of contracts resulted in the humans losing, again.

The challenge had twenty lawyers go up against the AI platform in consultation with law professors from Stanford University, Duke University, School of Law, and University of Southern California – both were given four hours to review five non-disclosure agreements (NDAs), identifying 30 legal issues, this included things like arbitration, confidentiality of relationship and indemnification. The scoring happened by accuracy in indemnifying each issue.

Humans took another tumble against the rising force of smart machines with an 85% accuracy rate. The AI smashed that out of the water with 95% accuracy. What makes this even scarier is it took the humans 92 minutes on average, but the AI completed it in 26 seconds.

This is a task lawyers undertake daily, but this still didn’t assist in the competition. The AI scoring the highest result achieved 100% accuracy in one contract, against the human whose highest result is 97%.

So, what does this mean for the legal industry?

When a computer can complete intricate and complicated jobs like this, it’s easy to see the threat posed to the industry as a whole, we see the looming threat of computerised legal offices dealing with every need in mere moments, but it’s not as dystopian as that.

“Having the AI do a first review of an NDA, much like having a paralegal issue spot, would free up valuable time for lawyers to focus on client counselling and other higher-value work,” said Erika Buell, clinical professor at Duke University School of Law, who LawGeex consulted for the study. 

These tools will come into the market, and there is a place for them, but like the computer on your desk it’s simply a tool and will only serve to make the process easier and quicker for both the solicitor and their clients. We feel there’s only good to come from this, but it’s a fascinating step into the future at the very least!

Aston Bond at Slough Aspire Careers Fair

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The Slough Aspire Careers Event is a community driven project aimed at giving career information to young people from the local area. The two day event, which took place on the 2nd and 3rd of February, allowed Aston Bond to share it’s industry knowledge and give valuable information regarding the legal profession to interested and enthusiastic year 9 and 10s Continue reading “Aston Bond at Slough Aspire Careers Fair”

You’re paying more tax than Facebook

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Social media giants Facebook are reported, by the Sunday Times, to have paid just £4,327 in corporation tax to the UK government in 2014.

The average UK worker, who receives a salary of £26,500, will pay £5,392.90 in income tax and national insurance. Yes you read that correctly; the multi-national corporation with global profits of over £1.4 billion pay less tax to the UK government than the average UK working citizen. Continue reading “You’re paying more tax than Facebook”

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