Contractual Redundancy Terms Create Unexpected Liability

A company which negotiated redundancy payments with its staff had a nasty shock recently at the hands of the Special Commissioner of Taxes.

The scenario was one which is quite common. The company wished to make employees redundant and negotiated severance terms with their union representatives. In this case, they used 'memoranda of agreement'. It is commonly considered that the relevant tax law (now contained in s401 ITEPA 2003) exempts the first £30,000 of a redundancy payment from liability to income tax and that was what was intended on both sides in this case. However, this is not always the case. The exemption applies only where the payment does not arise 'from the employment', being granted only when the payment arises from the termination of the employment, which is a different matter.

In this case, each memorandum operated technically as an amendment to the contract of employment of the employee being made redundant. The amendment gave the employee the right to accept short notice of redundancy on terms which gave them the right to receive a sum incorporating the redundancy payment and payment in lieu of notice. This change made the payment part of their contract of employment and therefore made it taxable.

It is not known what the effect of this decision on the employer was, but presumably it now has to pay the PAYE not paid on the taxable payments and to request its ex-employees to refund the overpayments – an unpleasant outcome for all concerned.

When negotiating redundancy packages, it is critical to get the terms right as failure to do so can have serious adverse consequences.