Employment laws generate a lot comment.  Hardly a day goes by without the media reporting scare stories about the employment rights of UK employees, which are depicted as being anti-competitive, unduly restrictive and in many cases overly generous. 

Each month we are exposing some of the most common employment law myths and explaining the reality behind them.  We are not pretending that employment law is easy – it isn’t, but generally it should not be difficult to get the basics right.

This month we look at whether the first £30,000 of any severance payment can be paid tax free.

Myth

Employers can always pay the first £30,000 of any severance payment tax free.

Busted

The general position is that it is only the first £30,000 of any non-contractual payment which can be paid free of tax.  Contractual payments made on termination of employment are subject to tax, even if they are expressed to be paid as compensation for the loss of employment or as an ex gratia payment.

If your employee’s contract of employment includes a payment in lieu of notice clause (“PILON”) and you decide to exercise this on termination, the notice payment is subject to tax, irrespective of how much is being paid.

Even if your employee does not have a contractual PILON clause, a payment made in lieu of notice may still be taxable if PILONs are routinely made and can be said to be an ‘automatic response to termination’.  Payments that are individually negotiated in an organisation that does not routinely make PILON’s are unlikely to be at risk of being deemed ‘auto-PILON’s’.

Payments made to compensate an employee for the loss of contractual benefits during the notice period, such as the use of a company car, health insurance etc are also taxable.

The £30,000 exemption is only available in respect of certain non-contractual payments including payment of damages, compensation for unfair dismissal, payments of statutory and non-statutory redundancy payments.

A handy table is set out below:

Click here to view table.