Foreign service exemption for termination payments

Produced by Tolley

The following Personal Tax guidance note Produced by Tolley provides comprehensive and up to date tax information covering:

  • Foreign service exemption for termination payments
  • Introduction
  • Who qualifies for the foreign service exemption?
  • What is ‘foreign service’?
  • Foreign service from 6 April 2013 onwards
  • Meaning of foreign service between 2008/09 and 2012/13
  • Meaning of foreign service before 2008/09
  • Full exemption
  • Test 1 ― foreign service is at least three quarters of total service
  • Test 2 ― total service has exceeded 10 years and the last 10 years of the employee’s service has been spent abroad
  • More...

Foreign service exemption for termination payments

Introduction

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 the definition below).

Where an employee has worked overseas and that employee receives a termination payment that falls within ITEPA 2003, ss 401–416 (see the How could a termination payment be taxed? guidance note), the termination payment may be:

  1. fully exempt from UK tax, or

  2. partially exempt from UK tax

It is a common mistake for employers and advisers to assume that a termination payment from a UK employment is not taxable on the employee if it is received whilst the employee is not UK resident. This is not correct. There is no territorial limitation within ITEPA 2003, s 401, although the income tax otherwise due may be fully or partly mitigated by the foreign service exemption, as discussed below.

Who qualifies for the foreign service exemption?

Prior to 6 April 2018, individuals qualified for full or partial foreign service exemption (also known as foreign service relief) by virtue of having all or part of their employment with the employer as ‘foreign service’, which is defined below.

However, where the employment is terminated on or after 6 April 2018 (in relation to payments or benefits received on or after 13 September 2017), the foreign service exemption is available only for individuals who:

  1. are non-resident in the year in which the employment is terminated (see the Determining residence status (2013/14 onwards) guidance note)

  2. are employed as seafarers (using the same definition as applies for the seafarers’ earnings deduction, see the Seafarers guidance note)

  3. receive a payment taxable within ITEPA 2003, ss 401–416 in relation to a change in employment duties or change in employment earnings

ITEPA 2003, ss 413(A1), 414(1)(za), 414B, 414C

Therefore, for these individuals, the foreign service exemption rules must be considered as normal (ie whether the full or partial exemption is available based on the

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