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Employee Reward Structures by Aidan Langley

Aidan Langley, author of ‘Employee Reward Structures’ provides a brief overview of an important exemption from employment income, and its interaction with redundancy payments.A termination payment that is not chargeable to tax under any other provision may be taxable under ITEPA 2003, s403. This section applies to any payment or other benefit received in connection with the termination of the holding of the office or employment, or any change in its duties or emoluments. It does not matter whether the termination payment is made by the employer or by another person.

The tax charge cannot be avoided by making the payment to the employee’s dependants, spouse or personal representatives. Any such payments are deemed to have been made to the employee [ITEPA 2003, s401(1)].

The tax charge arises in the year in which the payment or benefit is received by the employee [ITEPA 2003, s403(2)]. In relation to a cash payment, this means the year in which it is made, or a payment on account is made, or the employee becomes entitled to require payment of, or on account of, the benefit [ITEPA 2003, s403(3)(a)]. In relation to a non‐cash benefit, this means the year in which is it first used or enjoyed [ITEPA 2003, s403(3)(b)].

If the payment falls within ITEPA 2003, s403, it may be eligible for one or more of several exemptions under ITEPA 2003, Part 6, Chapter 3. These are:

�� the first £30,000 of the payment will be exempt from tax [ITEPA 2003, s403(1)];

�� there is an exemption for a payment made on the death, or on account of injury to or disability of the holder of an office or employment [ITEPA 2003,
s406];

�� there is no tax on termination benefits paid from an approved pension scheme
[ITEPA 2003, s407]; and

�� part or all of the payment may be exempt insofar as the employee has spent
part of his or her career working abroad [ITEPA 2003, s413].

The £30,000 exemption is set against payments made in earlier years before later years [ITEPA 2003, s404(4)] and against cash payments before non‐cash benefits [ITEPA 2003, s404(5)]. Payments made by one or more associated employers are aggregated and set against the exemption [ITEPA 2003, s404].

A payment that is taxable under ITEPA 2003, s403 can be taken into account as relevant earnings for the purposes of retirement annuity contracts [ICTA 1988, s623], but not for personal pension plans [ICTA 1988, s644(4)(b))]. Since it is employment income, it will be taken into account as relevant UK earnings in determining the annual limit on contributions to a registered pension scheme on or after 6 April 2006 [FA 2004, s189(2)].

Statutory Redundancy Payments

An employee who has two years’ qualifying service has a statutory right to a redundancy payment if he is genuinely made redundant. The amount of the payment is calculated using a formula – a ready reckoner is available on the Department for Trade and Industry’s website at:
http://www.dti.gov.uk/er/redundancy/payments‐pl808a.htm#What%20payments?

A statutory redundancy payment is exempt from income tax [ITEPA 2003, s309]. However, it reduces the £30,000 annual exemption under ITEPA 2003, s403.

Enhanced Redundancy Payments

The statutory redundancy entitlement is relatively low and many employers will wish to pay a greater, or “enhanced”, redundancy payment.

Assuming the employee does not have any contractual entitlement to an enhanced payment, it will be taxable under ITEPA 2003, s403, so that the £30,000 exemption will be available. Even if the employee does have a contractual entitlement, e.g. because there is a redundancy scheme incorporated into the terms of employment, the payment may still fall within ITEPA 2003, s403, if it is genuine compensation for loss of employment.

This analysis was confirmed by the case of Mairs v Haughey [1993] STC 569. This case held that a payment under an enhanced redundancy scheme was made to relieve the redundant employee for the fact that he was obliged to seek alternative employment; it was not itself earnings from the employment.

A second point was that a redundancy payment was usually paid after the employment had terminated and was therefore not earnings from that employment unless it had the character of deferred compensation payable under a contractual right.

HM Revenue & Customs draw a distinction between payments that are genuinely made to compensate the employee for the consequences of redundancy, and terminal bonuses. It accepts that the former fall within ITEPA 2003, s403, but not the latter. An employer who wishes to pay enhanced redundancy payments should submit the scheme to the PAYE Inspector for a ruling as to whether the payments can be treated as falling within ITEPA 2003, s403 [SP 1/94].

June 2005

Aidan Langley

About ‘Employee Reward Structures

The above article is adapted from ‘Employee Reward Structures’, published by Spiramus Press Ltd. For further information and to order a copy of this title, click here.

About the author

Aidan Langley, has practised as a solicitor and now works for a Big Four accounting firm, advising smaller companies on the design and implementation of short and long-term reward plans.