The U.K. government launched a consultation last month to consider how it can make the tax treatment of termination payments “simpler and fairer”.

Broadly speaking, the position is currently that the first £30,000 of any non-contractual termination payment can be paid free of deductions for tax and national insurance (NI), and that most other payments are subject to tax and NI. However, the tax rules underlying this are complex and following investigation, the government found that they were not fully understood by both employees and employers. To address this confusion, the government has proposed a number of changes, including the following:

• Removing the distinction between contractual and non-contractual termination payments.
• Replacing the current £30,000 allowance with an exemption that:
  • Only applies if the employee is terminated for redundancy (whether voluntary or compulsory) and has at least two years’ service; and/or
  • Increases according to length of service, up to a maximum figure.
• Introducing new exemptions for payments made in connection with wrongful or unfair dismissal and for injury to feelings awards made in discrimination claims.
• Possibly removing the existing tax exemption for employer contributions to employees’ legal fees in taking advice on settlement agreements.

It is too early to speculate on what changes will be implemented. However, current opinion suggests that the total amount that an employer will be able to offer tax free on termination will be significantly less than the current limit of £30,000. Nevertheless, a general simplification of the tax treatment of termination payments will be welcomed by many employers.