Redundancy could trigger tax headache warns lawyer

Companies and their higher-paid staff who are made redundant may be hit with a future tax bill of £16,140 per employee, a leading tax lawyer today cautioned. The warning comes as the latest UK-wide unemployment figures confirm a further 165,000 individuals joined the ‘dole‘ queue in the last quarter to January, with 2.03 million now out of work, the highest since 1997.

Caroline Colliston, a tax lawyer with UK-wide law firm Maclay Murray & Spens, said: “Too many employers wrongly assume that sums of up to £30,000 can be paid free of tax to all departing employees, which is not always the case. More often than not, employees who resign voluntarily are not entitled to the first £30,000 tax free and any payment they receive is regarded as, and taxed as, a golden handshake or terminal bonus.

“While redundancy may look like a tempting option, a failure to address the tax implications can result in both the employer and employee facing large tax bills. A 40 per cent tax payer will have additional tax of £12,000 to pay on £30,000, as well as £300 of National Insurance Contributions (NICs). Additionally, the employer will be liable for £3,840 in Class 1 NICs.”

Payments which form part of the terms and conditions of the employee’s employment, for example accrued holiday pay, pay in lieu of notice and commission payments, are taxable in the normal way through the payroll. Further complexities occur when pay in lieu of notice terms allow the employer to decide on a case-by-case basis whether to pay. Failure to assess and document this process properly could lead to HMRC arguing a payment is in fact just pay in lieu of notice, dressed up as compensation.

Where the employment ends by reason of redundancy, all statutory redundancy payments are tax free. Any enhanced redundancy payments should also be tax free up to £30,000, as long as there is genuine redundancy for the purposes of the Employment Rights Act.

Colliston concluded: “An increasing number of organisations and their former staff are realising, that the failure to consider and manage the application of the tax charge in redundancy situations can be costly. While it is possible to include an indemnity in any compromise agreement, it is also critical for employers to review the tax risk up-front and avoid arguing about the position later."