Foreign service exemption for termination payments

By Tolley in association with Sue El Hachmi of Osborne Clarke LLP
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The following Employment Tax guidance note by Tolley in association with Sue El Hachmi of Osborne Clarke LLP provides comprehensive and up to date tax information covering:

  • Foreign service exemption for termination payments
  • Full exemption
  • Test 1 ― the foreign service is at least three-quarters of total service
  • Test 2 ― the total service has exceeded 10 years and the last 10 years of the employee’s service has been spent abroad
  • Test 3 ― the total service has exceeded 20 years and at least half of total service has been spent abroad, including 10 of the last 20 years
  • Partial exemption
  • What is ‘foreign service’?
  • Claiming the relief
  • Double tax treaty

An exemption from tax can apply to termination payments where the employee worked all or part of the employment period overseas (which the legislation terms ‘foreign service’, see definition below). For UK residents (with the exception of seafarers), this relief no longer applies to terminations on or after 6 April 2018, and payments made on or after 13 September 2017. There is no change in the relief in relation to change of duties or earnings.

ITEPA 2003, ss 413–414C

Where an employee has worked overseas and receives a payment on termination which fails to be taxed under ITEPA 2003, s 401 (see the How could a termination payment be taxed? guidance note), that payment may either be fully exempt from tax or partially exempt.

Full exemption

The full exemption rules are complex. It is best, once it has been established that the individual is not resident in the UK, to work through them test by test. If any of the three tests discussed below are met, then the termination payment is completely tax-free.

ITEPA 2003, s 413

See Example 1.

Test 1 ― the foreign service is at least three-quarters of total service

If an employee has been in service for 10 years, and has spent eight of those 10 years abroad, the foreign service comprises more than three-quarters of total service, so the termination payment is fully exempt so long as the employee is not resident in the UK, where the termination is, on or after 6 April 2018.

Test 2 ― the total service has exceeded 10 years and the last 10 years of the employee’s service has been spent abroad

If an employee has spent 15 years working for his employer and the last 12 years were spent working in the US, the foreign

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