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:
Termination payments are payments made to an individual at the end of his employment. The law on termination payments also covers payments for varying the terms of an individual’s employment relating to their pay and duties (which can include loss of rights).
Termination payments can take the form of cash or benefits in kind. The payment will either be fully taxable, partially taxable or fully exempt depending on the nature and the amount of the payment.
Depending on the circumstances, termination payments can be treated for tax purposes as:
It is the employer’s responsibility to tax the termination payment correctly and therefore bears the risk of tax and penalties if the treatment is wrong. This is an area where HMRC sees frequent mistakes in the tax treatment and it has targeted such payments in the past.
See the Termination of employment guidance note, and other notes in the ‘Dismissal’ sub-topic, for a refresher of the essential employment law on dismissal.
Note that all case references quoted in this guidance note are subscription sensitive.
Before deciding how to treat the termination payment for tax purposes, the total payment must be broken down into its component elements. Once identified, the tax treatment of each element is decided by matching it to the categories above.
So, how do we identify the component elements of the termination payment? It relies broadly on the documentation agreed by the employer and employee. See the Settlement (compromise) agreements guidance note for discussion of the importance of this when settlement agreements are used.
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