On 6 April, new regulations come into force which will have the effect of changing the PAYE tax treatment of payments made to employees after their employment has ended, as well as limiting the tax concession in relation to an employee’s legal costs paid by an employer on termination of employment.

1. Termination payments

a) The Current Position
Under the current Regulations, (1) tax on termination payments must be deducted at basic rate, and (2) the employee’s tax code is not taken into account for the purposes of any payments made to an employee after their P45 has been issued.  Under the current Regulations, tax is deducted using tax code ‘BR’.  As a result, if an employee is liable to tax at the higher (40%) or additional (50%) rate of tax, HMRC then needs to collect the underpayment from that individual through their Self-Assessment tax return. This normally results in an immediate cash-flow benefit for the individual with any additional income tax only becoming due by 31 January following the end of the tax year. This compares favourably to tax collected at it arises under PAYE.

b) The New Position
As of 6 April 2011, the current Regulations will be amended by the Income Tax (Pay As You Earn) (Amendment) Regulations 2011, in terms of which HMRC are changing the code which employers are authorised to operate for payments made to an individual after they have left their employment from ‘BR’ to ‘0T’.  Using code ‘0T’ will ensure that income tax is deducted at basic, higher or additional rate according to the individual’s level of earnings. This will therefore turn the cash-flow benefit in favour of HMRC since they will no longer have to wait to recover tax underpayments from higher rate and additional rate taxpayers.

c) Implications for Employers
HMRC have contacted employers with regards to this change, and further specific details on how employers should deal with this in practice can be found here.

2. Legal Fees

a) The Current Position
There is currently a tax concession which allows an employee’s legal costs on termination of employment to be paid by the employer free of tax if they are either ordered to be paid by a court or tribunal, or paid direct to the employee’s lawyer pursuant to a compromise agreement.

b) The new position
The tax concession is to be withdrawn and will now be formally enacted by Regulation 10 of the Enactment of Extra-Statutory Concessions Order 2011, which will affect payments made on or after 6 April. 

It had initially appeared that this new Order would significantly restrict the tax concession as it would only apply to cases involving a court or tribunal costs order, or a formal compromise agreement complying with section 203 of the Employment Rights Act 1996.  HMRC have now confirmed that the previous tax concession will continue to apply in relation to compromise agreements which refer only to legislation such as the Equality Act 2010, but not the Employment Rights Act 1996, until such time as an amendment is made to the new Order.  Additionally, HMRC is currently looking into the issue concerning cases involving COT3 agreements reached through Acas conciliation, and other settlement agreements from legislation, and if necessary will seek an amendment to the new Order in relation to this.

Other statutes which contain provisions of their own as to how the conditions regulating compromise agreements are satisfied (e.g. the Trade Union and Labour Relations (Consolidation) Act 1992), should have been mentioned in the new Order.  Unfortunately this is not the case and HMRC is currently being asked to make its position clear on these outstanding issues.

Further information
For further information on the issues raised in this ezine, please contact Murray McCall, Alan Masson, or Martin Campbell or your usual contact within the Employment Team.

This bulletin is for general information only and does not constitute legal, investment or other professional advice. Please contact us should you require advice on any particular legal issue. Anderson Strathern LLP accepts no responsibility for any loss that may arise if reliance is placed on any information or opinions expressed in this bulletin.