Are changes to the tax status of settlement payments on the way?

The Government is consulting on the tax treatment of payments made to employees upon termination of their employment.

Currently, the general rule is that any contractual payment is subject to tax whereas non-contractual payments are only taxable over £30,000. Amongst the proposals for reform are:

• introducing a two year qualifying period, so no employee can receive a tax-free termination payment for the first two years of their employment;
• removing the distinction between contractual and non-contractual payments;
• changing the fixed £30,000 tax-free sum to an amount which increases with an employee’s length of service (although there is no suggested starting figure or incremental increase as yet); and
• making injury to feelings awards subject to tax for some or all of the award.

The aim of the proposed reform is to make the position clearer so employers and employees can have certainty over the status of payments made and received. However, if the Government proposes removing the distinction between contractual and non-contractual payments, it won’t want to be left out of pocket. The introduction of a qualifying period and a staged tax-free amount is unlikely to find favour amongst employees who currently enjoy the right to the £30,000 exemption from day one.

The consultation is open until 16 October 2015. The full consultation document can be found here.