tax
When agreeing a termination payment with a departing employee, a company may need to take into account the rules on the taxation of termination payments. These are set out in the Income Tax (Earnings and Pensions) Act 2003 and various concessions that the Inland Revenue has made over the years. The basic principles are these:
Any part of the financial settlement that represents a payment for the employee's work during employment is taxable in full. That will include any payment made under a term of the employee's contract, including a term giving the employer power to make a payment in lieu of notice. It may also cover a discretionary payment such as a discretionary bonus.
Any payment made to the departing employee in return for his or her agreement to enter into a restrictive covenant is also taxable in full.
The first £30,000 of any remaining elements of the financial settlement, such as ex gratia payments or redundancy payments, is normally exempt from tax.
In the case of senior employees in particular, the tax treatment of termination payments can have a substantial impact on the size of the settlement reached and the way in which it is structured. Companies may therefore wish to obtain specialist tax advice when drawing up settlements.