Unfortunately, in the current economic conditions many European employers cannot avoid making redundancies. This is always a hard situation for both employers and employees.
Tax planning plays an important part in the redundancy process as it can minimise the cost of redundancy payments to the business and maximise the benefit of the payments to the employees.
This article looks at the most common ways of structuring redundancy payments in a tax-efficient manner in France and the United Kingdom to help employers make those final termination payments without headache added to heartache.
The term “redundancy” does not have a universal meaning, but in this article we use the meaning of an employee’s job disappearing because the employer needed to reduce the workforce as a result of economic pressures affecting the employer’s business.
In France, payments from employers to employees are generally taxed as salary income and subject to:
- Income tax (charged on the employee);
- Social security contributions (charged on both the employer and the employee); and
- Social levies (Contribution Sociale Généralisée or CSG and Contribution pour le
Remboursement de la Dette Sociale or CRDS) (charged on the employee).
Payroll withholding is required in respect of social security contributions but not in respect of income tax, except in the case of French non-residents. The tax burden in relation to termination payments on redundancy can potentially be reduced in relation to employer and employee social security contributions, employee income tax and social levies, as described below.
Payments made under a collective redundancy plan (in a company with at least 50 employees) within the meaning of articles L. 1233-32 and L. 1233-61 to L. 1233-64 of the French Labour Code are automatically exempt from income tax and social security contributions.
Payments which are not made under a collective redundancy plan in a company with at least 50 employees are also exempt from income tax and social security contributions but only as to the portion of the payments which does not exceed:
- an amount equal to double the gross annual remuneration paid to the employee during the calendar year preceding the dismissal, limited to EUR 205,848 for 2009 (this limit is reviewed each year as it is calculated as six times the annual social security threshold); or
- 50% of the dismissal payments made to the employee, limited to EUR 205,848 for 2009; or
- the dismissal payment set out in the relevant collective agreement or the French Labour Code (without any limit).
In all cases, payments are exempt from social levies, but only as to the portion of the payments which does not exceed the dismissal payment set out in the relevant collective agreement or the French Labour Code. If a dismissal payment exceeds thirty times the annual social security threshold, the full amount is subject to social levies.
All termination payments to directors are subject to income tax, social security contributions and social levies as salary income. However, in situations where the director is obliged to quit his/her functions, in particular when he/she is revoked, the termination payments are exempt from income, security contributions and social levies, but only for the share of the payments which does not exceed:
- an amount equal to double the gross annual remuneration paid to the director during the calendar year preceding the dismissal, limited to EUR 205,848 for 2009; or
- 50% of the dismissal payments made to the employee, limited to EUR 205,848 for 2009.
As for employees, if a dismissal payment made to a director exceeds thirty times the annual social security threshold, the full amount is subject to social levies.
Payments in lieu of notice
No exemption is available for payments in lieu of notice, which are subject to income tax, social security and social levies in the same way as normal salary income.
The tax burden in relation to termination payments can potentially be reduced in relation to employer and employee National Insurance contributions (NIC) and employee income tax, as described below.
Statutory redundancy payments
There is no income tax or NIC to pay on statutory redundancy payments. The current level of statutory redundancy is limited to £350 per year of service, up to 20 years’ service and multiplied by up to 1.5 depending on the age of the worked, so the maximum statutory redundancy amount is £10,500.
Termination payments in excess of statutory redundancy
There is an exemption from income tax and NIC for termination payments made in addition to statutory redundancy payments provided that such termination payments only relate to the termination (as compensation for loss of office) and not to services performed under the employment contract.
For income tax, the exemption is limited to the first £30,000 of such a payment but there is no cap on the exemption from NIC. Any statutory redundancy payment made uses up part of the £30,000 exemption.
Interaction with other countries
There is no £30,000 limit on a termination payment made in respect of foreign service if:
- the employee’s foreign service is at least ¾ of the employee’s total service; or
- the last 10 years of the employee’s service with the same employer has been spent overseas; or
- neither of the above tests apply, and the employee’s total service has been more than 20 years, and at least half of the total service has been spent overseas, including 10 of the last 20 years.
If none of the above three tests is met, then only the portion of the termination payment which relates to foreign service is exempt. This is calculated by deducting the £30,000 exempt amount from the total payment and then multiplying the remaining taxable amount by the length of foreign service divided by the length of total service.
No exemption is available for:
- A payment in lieu of notice (PILON) if this is paid in accordance with the terms of the employment contract, staff handbook, union agreement or the customary practice of the employer. However, if the PILON is genuinely made without any contractual obligation, then it will come within the £30,000 exemption as described above.
- A payment to an employee which relates to a restrictive covenant, e.g. that stops the employee from working for a competitor for a period of time.
Application of double tax treaties:
In a recent UK tax case, Resolute Management v HMRC (2008), a US citizen received a termination payment in the UK, which the Special Commissioner found qualified for the £30,000 exemption in the UK under UK domestic law.
The question of whether the UK or the US had taxing rights in respect of the payment under the US/UK double tax treaty was considered.
The Special Commissioner found that an ex gratia termination payment did not consist of "salaries, wages or other similar remuneration" under Article 14 of the treaty but instead the payment was "other income" under Article 22 of the treaty.
This meant that the US, not the UK, had the right to tax the termination payment under international law.
Approach to HMRC
For employers making termination payments free of income tax and NIC, and therefore without operating payroll on the payments, there is a risk that HM Revenue & Customs (HMRC) may investigate these to make sure that this is the correct treatment rather than a PAYE failure or tax evasion. If the employer has not paid the correct PAYE and NIC, then HMRC will seek to recover these liabilities from the employer, plus penalties and interest.
In order to minimise worry, employers can request HMRC to give clearance for non-statutory redundancy schemes at an early stage.
What should the employer do before making payments to redundant employees? In each location:
- Review employment contracts, staff handbooks, works council or trade union agreements.
- Check the employee's international mobility history.
- Check if any particular customary practice has been established in dealing with previous redundancies.
- Obtain tax advice before making any communications to employees / works councils / trade unions.