HMRC has published a consultation paper which proposes significant changes to how termination payments made to employees are taxed. The suggested reforms include removing the  distinction between contractual and non-contractual termination payments, so that all payments made  in connection with an employee’s termination will be subject to income tax and NICs; aligning  income tax and NICs; and reforming the existing £30,000 exemption from income tax and NICs.

HMRC intends to introduce a more targeted exemption than currently exists and a number of options  are discussed in the consultation paper. The most radical suggests that the exemption be limited to  cases of statutory redundancy. Other suggestions include a blanket exemption for all termination  payments, but up to a level below the existing £30,000, or an exemption that is based on the  employee’s years of service. The latter is the Government’s preferred approach but the exemption  would only be available in situations where the termination is made in connection with redundancy,  including voluntary redundancy. An employee would qualify only after 2 years’ service and the level  of the exemption would then increase for each year of service to a maximum set level. If this main  exemption were to be limited to redundancy, the consultation paper also suggests two additional  exemptions: one in connection with unfair or wrongful dismissal and the other in connection with  compensatory payments made in discrimination cases.

The proposed changes are intended to remove the “complexity and misunderstanding” of the current  taxation system, whilst also reducing the possibility for employers and employees to take advantage  of these existing complexities. Under the current system, non-contractual termination payments are  only taxable where they exceed £30,000 regardless of the reasons for termination, and so the  proposed changes are likely to result in a reduction to the number and amount of severance payments  that qualify for tax relief.

The consultation period is open until 16 October 2015 following which the Government will publish  details of the consultation responses and expects to make an announcement in the last quarter of  2015 on any decision made in light of those responses.