PAYE Changes
HMRC have announced plans to amend the Income Tax (Pay as You
Earn) Regulations 2003. This will effect employer's obligations
when making termination payments to former employees, for example,
under a compromise agreement.
Currently, where a termination payment is made to a former
employee who has been issued with a P45, the employer has to deduct
income tax at the basic rate of 20% by using the BR code,
regardless of whether the employee pays a higher (40%) or
additional (50%) tax rate.
However, it is proposed that, from 6 April 2011, the employer
will be required to deduct tax using the OT code, and consequently,
tax will be deducted at the employee's marginal rate. This means
that the HMRC will receive the maximum amount possible, and the
employee will not receive any tax due to him until he submits his
tax return and HMRC makes a repayment.
This change in the regulations will not affect the existing tax
exemption applicable to termination payments of £30,000 and
below.
Recent case summary: Chidi Anthony Oui - Obihara v HMRC
[2010]
This recent judgement is an example of how payments under a
compromise agreement are likely to be apportioned between taxable
and tax-free amounts where the agreement does not provide for any
apportionment. It highlights to employers the importance of
drafting the compromise agreement so that there is no confusion as
to the tax treatment.
Facts
The employee entered into a compromise agreement with his
employer following allegations of racial discrimination and
harassment.
The employee's employment was terminated and he received a
payment of £500,000.
The employee did not include the termination payment on his
self-assessment tax return on the basis that he did not consider it
to be income from employment or a payment of compensation concerned
with the termination of his employment, but rather compensation for
discrimination which is not subject to income tax.
HMRC issued a closure notice amending the employee's tax return
to the effect that a portion of the payment was treated as damages
for injury to feelings and, therefore, was not taxable. However,
the balance was treated as a payment received in connection with
the termination of his employment and therefore, was subject to
tax.
The employee appealed the closure notice.
Decision
The Tribunal held that there was nothing in the agreement that
apportioned the payment between (1) compensation for termination of
employment, and (2) compensation for injury to feelings. Therefore,
the payment was held to be made in connection with both.
£165,000 was apportioned as a payment in connection with the
termination of employment and, since the first £30,000 was tax
free, £135,000 was subject to tax.