The Government has recently launched two separate consultations. One is on simplifying tax and NICs on employment termination payments and the other concerns possible changes to the “IR35” regime, which affects individuals who provide their services through personal service companies.
The tax treatment of termination payments made to departing employees is a relatively complicated area, with errors or disagreements with HMRC easily occurring and mistakes proving expensive. However, the rewards of correct categorisation can be high: currently, non-contractual (but not contractual) termination payments are free of NICs and are only taxable to the extent they are more than £30,000, and complete exemption is possible in some cases. Last year, the Office of Tax Simplification (OTS) concluded in its report on employee benefits and expenses that the current system of taxing termination payments was complex, unfair and led to scope for avoidance.
Options for reform of £30,000 exemption
The following options for reform are considered in the Government consultation document:
- Blanket exemption – Whilst a blanket tax exemption for the first £30,000 of all termination payments would be simple and easy to administer, both the OTS and the Government consider this option to be financially unsustainable for the Government.
- Exemption linked to statutory redundancy – This was the OTS recommendation, although this option would remove many of avoidance opportunities the Government is looking to tackle, the Government does not intend to take this option forward due to the large groups of workers who do not qualify for statutory redundancy e.g. employee shareholders, parliamentary staff and civil servants.
- Exemption linked to statutory or voluntary redundancy payments based on length of service – This is the Government’s preferred option, and would be calculated according to the number of years of service the employee has completed, but would only be available to employees who have completed at least two years of service. Years of service with the same employer, associated employers or following a TUPE transfer would be counted. Whether or not the payment was contractual or not would no longer matter. The amount of any cap is not specifically mentioned, although it is clear that a cap will be imposed. Some reorganisations can result in dismissals which fall short of the statutory definition of redundancy - often categorised as being for the potentially fair statutory reason of “some other substantial reason (SOSR)”. The dividing line between redundancy and SOSR dismissals can be narrow and this point may well feature in the consultation responses as it is difficult to see why the latter should automatically be excluded.
The Government is also considering other exemptions which remove the liability to income tax on termination of employment. The consultation document notes that removing all of the existing exemptions would be the simplest approach. However, the Government proposes to retain certain exemptions for injury or disability and payments to the Armed Forces, but is minded to remove the current tax exemption for termination payments relating to working overseas.
On the plus side, if the statutory or voluntary redundancy payments exemption is adopted, the Government proposes to create two new categories of exemption:
- compensation for unfair or wrongful dismissal; and
- compensation for loss of future earnings following discrimination.
There will be an overall cap, although the consultation document does not set out the proposed level of this.
One issue not addressed in the consultation is whether share-related remuneration received on termination is capable of falling within the terms of any exemption. Currently it is not able to benefit from the termination payment exemptions at all.
The Government is also proposing to align the income tax and NICs treatment of termination payments, with the current total NICs exemption in respect of ex-gratia termination payments being abolished. While this is simpler and accords with a general Government consultation to align employment income and NICs, it will clearly prove more costly for employers and employees alike.
At this stage it is difficult to predict how tax law will change. The overall result is a very confusing set of proposals which appear to end up with the possibility of more rather than fewer exemptions which suggests the potential for greater rather than less confusion. The removal of the somewhat artificial historical distinction between the taxation treatment of contractual and non-contractual entitlements is in principle welcome but the principal aim appears to be to ensure no overall decline in tax receipts as much as the creation of an easier-to-administer system.
The deadline for responses to the consultation is 16 October 2015, with any Government announcement of action being taken scheduled to be made in December.
To access the consultation document, click here.
The Government announced in the July Budget that HMRC would start a dialogue with business on how to improve the effectiveness of the existing intermediaries legislation, commonly known as IR35.
IR35 operates to tackle disguised employment. It applies where an individual sets up his own company and then contracts with clients through that company rather than personally. If the individual would have been an employee of the client had the individual contracted personally with the client, IR35 taxes the income the personal service company receives as if it were employment income.
Even if IR35 does apply, the end client user does not currently have any compliance responsibilities, which makes it relatively safe tax planning for clients to engage with “consultant companies” through the IR35 regime as the risk is the individual’s (or strictly, his company’s) rather than the clients.
The Government, however, is of the view that there is widespread non-compliance in this area and is therefore trying to level the playing field between direct employees and those who work in a similar manner to direct employees but through their own limited companies.
Options for reform
The discussion document considers the options of administrative changes and increased policing of compliance by HMRC. However, neither of these options is favoured by the Government as they fail to address the shortcomings of the current rules and HMRC does not consider it has sufficient resources to cope with the burden that would result from an approach which adopted an increased level of intervention and analysis to assess compliance.
An alternative option being considered is for increased involvement by engagers of personal service companies in ensuring the correct amount of tax is paid by those companies. Under such an approach, those who engage an individual though a personal service company would need to consider whether that individual would have been an employee if engaged directly, and, if so, deduct the same amounts of income tax and NICs as they would for direct employees.
In order to ease the complexity of determining whether or not the legislation applies, the Government is considering simplifying the IR35 tests - including making engagements above a certain duration automatically fall within IR35 as well a possible adoption of criteria which if satisfied would result in deemed employment. Given that it is often (very) difficult to categorise individuals as employees, workers or independent contractors, the identification of suitable criteria may well prove problematic in practice.
The Government acknowledges the increased burden this would place on engagers and welcomes views on this proposal.
Overall, as we have already seen greater responsibility placed on engagers in the public sector to ensure that when engaging personal service companies they are working compliantly, it would be unsurprising and a natural progression to see that extended to the private sector. If these proposals are implemented and the compliance burden is shifted towards clients, companies may become more reluctant to engage personnel through personal service companies. An alternative may be engagement as a worker, rather than as an employee: however, businesses would, for example, have to weigh up the risks of being exposed to further obligations in relation to statutory holiday pay under the Working Time Regulations for which both workers and employees qualify but not genuine independent contractors.
When IR35 was itself introduced in 2000, the Government’s initial proposals included placing burdens on those engaging personal service companies, but these were withdrawn after much lobbying. Similar arguments will no doubt be raised this time. However, the tax climate and intrusiveness of tax compliance is markedly different in 2015, and so what was too complicated in 2000 may well now be something business just has to implement and could lead to a dramatic reduction in the use of personal service companies if the default position in effect becomes that they are taxed as if they received employment income, unless they and the end client can show otherwise.
Comments and suggestions are invited by the end of September 2015.
To access the discussion document, click here.