Very often as part of the terms of a compromise agreement an employee may receive compensation for loss of office which exceeds the statutory minimum amount that an employee is entitled to by law.
To determine whether tax is payable on monies received as compensation for redundancy, very much depends on whether the various elements that make up that termination payment is a payment by the employer in return for services performed under your contract of employment. If the payment or part of that compensation is for services rendered, then this element of the compensation will be taxable under the Income Tax (Earnings & Pensions) Act 2003.
So, for example, a payment by an employer in respect of notice that an employee is entitled to under a contract (written or oral) but where the employer does not ask the employee to work his or her notice (PILON), this element of the redundancy pay will be taxable because it is a contractual right of the employee to receive pay during his or her notice period.
If on the other hand, say an employer decides to compensate an employee for loss of office, with for example a sum of money that an employee is not entitled to under his or her contract of employment, then this will attract tax by HM Customs & Revenue.
So, to understand whether tax is due on an employee's termination payment, the starting point is to ask whether the termination payment is contractual i.e is the employee entitled to the payment under contract. If the contract or the practice of the employer (i.e. regular practice by an employer of giving certain benefits to employees can be implied into contract) identifies a legal right to receive a payment on termination of employment, then this will likely be construed by Revenue and Customs as taxable.
If there is any doubt whether tax is payable on all or part of a payment within a redundancy compromise agreement, Revenue and Customs may ask to see the employee's contract of employment and any other documentation for it to decide whether there was a contractual entitlement or a practice by the employer to give certain payments on termination of employment. In other words, if there is no reference to a contractual entitlement the Revenue can still claim that tax is due if it can prove that there was a "reasonable expectation" on the part of the employee to the termination payment by looking at past practice and policy of the employer to see if other employees received such payments in the past.
Under current tax legislation, the maximum amount of a termination payment that is exempt from income tax is currently £30,000. To receive the full tax allowance on £30,0000, none of the the termination payment must be part of a contractual entitlement. All amounts, whether for services rendered or not, that exceed £30,000 is liable to tax at the employee's normal tax rate.
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