How could a termination payment be taxed?

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:

  • How could a termination payment be taxed?
  • Analysing a termination payment
  • Terminology
  • Agreement
  • Apportionment of payment
  • Legislative scheme
  • Termination payments ― order of priority of legislation
  • Benefits from an EFRBS
  • Earnings
  • PENP
  • More...

How could a termination payment be taxed?

Termination payments are defined in the Termination payments ― overview guidance note.

Termination payments can take the form of cash, benefits or both. 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 categorised as one of the following, each with their own tax and NIC treatment:

  1. earnings ― see the Taxation of cash payments guidance note

  2. benefits in kind ― see the Taxation of non-cash payments guidance note

  3. restrictive covenants ― see the Taxation of payments for restrictive covenants guidance note

  4. benefits from an employer-financed retirement benefits scheme (EFRBS) ― see the Employer Financed Retirement Benefit Schemes (EFRBS) guidance note

  5. termination payments (this includes benefits) within ITEPA 2003, s 401 ― see the Termination payments ― overview guidance note

It is the employer’s responsibility to correctly operate PAYE for termination payments and they, therefore, bear the risk of potential unpaid tax and NIC as well as interest and penalties if the treatment is wrong. As this is a high-risk area, HMRC will prioritise this in compliance work. HMRC guidance on termination payments starts at EIM12800. See also Simon’s Taxes E4.8 and the Termination payments (B) video.

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.

Analysing a termination payment

Before deciding how to treat the termination payment for tax purposes, the total payment

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