News Article - Everyone knows that

The problem with a lot of things in life that "everyone knows" is that they aren't always true. This is especially so when it comes to tax. Many people for example, think that a payment of up to £30,000 to an employee who is being laid off is tax free. Sadly, it isn't that simple.

Statutory redundancy pay is free of income tax and national insurance. The amount will depend on age, length of service and rate of pay. You can find useful information on calculating the amount on the Directgov or Business Link websites. Any payments in excess of statutory redundancy pay will, however, not automatically be tax free. The crucial point is that for any additional payment to be tax free, it must not be earnings. If the contract of employment contains provision for such a payment or there is reference in the staff rules or handbook it will almost certainly be taxable, as it will be if there is an established practice in the business of making such payments.

Documentation is very important and great care needs to be taken over what is recorded in letters, notes of meetings and board minutes to ensure that misleading words are not used. Relating the payment to past services is generally fatal to the chances of successfully arguing that the £30,000 exemption applies. Particular problems arise when payments in lieu of notice are involved or where someone is near to retirement age. Understanding the precise circumstances is critical.

Some employers rely on an undertaking by the employee to reimburse any tax or national insurance that falls due if HMRC subsequently challenge a payment made tax free, but it can be difficult to enforce such undertakings in practice, especially if the challenge from HMRC is made some years after the event. It is possible to avoid this problem by asking H M Revenue & Customs for an opinion before the payment is made. HMRC will ask for full details including the way in which a payment has been calculated and copies of any correspondence, the contract of employment and staff rules together with a description of the circumstances surrounding the payment. Normally HMRC will give a view – which can, if necessary, be challenged - within 30 days.

This is a very complex area and professional advice on the legal and tax aspects should always be sought. The cost of getting it wrong can be considerable.

Paul Aplin is a tax partner with A C Mole & Sons and a former chairman of the Institute of Chartered Accountants in England & Wales Tax Faculty. He can be contacted on 01823 624450, email paulaplin@acmole.co.uk. Bridgwater based tax partner Paul Kingdom can be contacted on 01278 446088, email paulkingdom@acmole.co.uk.