Termination payments and the £30,000 exemptionMonday, April 18th, 2011
The Upper Tax Tribunal decides that payments in lieu of redundancy, even if paid years in advance of termination, qualify for the £30,000 exemption.
On 6 December 2010, in the case Colquhoun v Revenue & Customs, the Upper Tax Tribunal overturned the January 2010 decision of the First-tier Tax Tribunal relating to the £30,000 tax exemption that is available in specific circumstances for termination payments.
Section 403 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) provides a tax exemption for the first £30,000 of payments and benefits made in respect of three situations, namely
- termination of employment,
- a change of employment duties, or
- a change in employment earnings.
Section 404 of ITEPA allows the £30,000 exemption to be used only once in the same employment or associated employments.
In 1997, Mr Colquhoun received a buy-out payment in return for the phasing out of a very generous redundancy scheme. Under that arrangement, he received a payment of £33,148, the first £30,000 of which was not taxed as it was, at the time, deemed to qualify for the £30,000 exemption.
In 2005, when Mr Colquhoun’s employment was terminated on the grounds of redundancy, the employer did not reduce the £91,594 termination payment by £30,000 for tax purposes but taxed the full amount. However, Mr Colquhoun believed he was entitled to the £30,000 exemption so claimed a deduction of that amount on his self-assessment Return. HMRC subsequently refused to allow the deduction and Mr Colquhoun appealed.
The First-tier Tribunal decided that a payment made to buy out a contractual entitlement does not fall within any of the permitted circumstances. As a result, the £30,000 was still available to be used against Mr Colquhoun’s termination payments in 2005. The Tribunal did not comment on the tax status of the 1997 payment and, in any event, it was too late for HMRC to seek to tax that payment retrospectively.
HMRC subsequently appealed against the First-Tier Tax Tribunal decision, on the basis that
- the current legislation derives from 1960 anti-avoidance measures that were widely-drawn and intended to cover, not just redundancy payments, but payments in lieu of redundancy,
- the legislation does not require actual termination, or that a payment be made in connection with termination, whether or not the termination actually occurs, and
- the legislation does not require a payment to be made at the same time as the termination.
The Upper Tax Tribunal agreed with these arguments, referring to the very general way in which the current legislation is couched, using such terms as “indirectly” and “otherwise in connection with”. HMRC’s appeal was allowed and Mr Colquhoun has to pay tax on all of his 2005 termination payments.
As a result of this decision, HMRC has updated its guidance in the Employment Income Manual, namely that
- the scope of the section 403 exemption “includes a payment made for giving up rights in a redundancy scheme even though no termination occurs when it is paid”,
- the full scope includes payments and benefits received “directly or indirectly in consideration or in consequence of, or otherwise in connection with, the termination or change”, and
- the phrase “otherwise in connection with” was equated in HMRC v Colqhoun with “in any way connected with”.