Foreign service exemption for termination payments

Produced by Tolley in association with Sue El Hachmi of Osborne Clarke LLP

The following Employment Tax guidance note Produced 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
  • What is ‘foreign service’?
  • Who does the exemption apply to?
  • 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
  • Claiming the relief
  • Double tax treaty

Foreign service exemption for termination payments

What is ‘foreign service’?

A full or partial exemption from UK tax is available on a termination payment where the employment included a period of ‘foreign service’. The definition of ‘foreign service’ is complex as it reflects the different rules that have applied to the taxation of foreign earnings over the years. The Office of Tax Simplification review of employee benefits and expenses final report published on 31 July 2014 sets out that HMRC noted that some employers played safe and did not apply the relief because it is too complicated.

In respect of service from the 2003/04 tax year onwards, foreign service in relation to a particular employment means service such that the earnings from that employment were either:

  1. not relevant earnings

  2. earnings in respect of which a 100% seafarers’ earnings deduction was available

ITEPA 2003, s 413(3)

In respect of service from the 2013/14 tax year onwards, foreign service in relation to a particular employment means service:

  1. to the extent that it consists of duties performed outside the UK in respect of which earnings would not be relevant earnings

  2. such that the earnings from that employment were earnings in respect of which a 100% seafarers’ earnings deduction was available

ITEPA 2003, s 413(2A)

In each case, the test is a negative test. If earnings are found to be relevant earnings, the exemption does not apply.

The definition of relevant earnings has changed on a number of occasions and is set out in ITEPA 2003, s 413(3A), (3ZA):

  1. from tax

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