It has long been established that payments of up to £30,000 for termination of employment (such as redundancy payments), usually paid under a compromise agreement, would be tax free if they are not paid pursuant to a contractual obligation in the employment contract. The recent decision in Reid v HMRC considered the tax status of all elements of a termination payment in an employment compromise agreement.
Mr Reid was a director of a company and also entered into a share option agreement with his employer. Under the share option agreement Mr Reid purchased share options in his employer company for £30,000. However the purchase price was refundable if Mr Reid ceased to be employed by the company prior to exercising the options. Mr Reid eventually resigned and entered into a compromise agreement with the company. The compromise agreement provided for Mr Reid to receive the sum of £77,731 by way of compensation, less any income tax or national insurance that the employer was required by law to deduct (the "Termination Payment"). The compromise agreement contained no further detail regarding the Termination Payment other than to state that it included any statutory redundancy pay due to Mr Reid; no reference was made to the repayment of the £30,000 paid by Mr Reid for the share options although this was refunded by the company. Mr Reid subsequently filed his self-assessment tax return, claiming that the £30,000 he paid for the share options was a refund due to him by the company and, as such, was not taxable as it was not income.
HMRC sought assessment of this claim. In dismissing Tax Tribunal found that because the compromise agreement did not characterise any part of the Termination Payment as a refund then it was income. The compromise agreement also included an entire agreement clause which served to supersede the previous agreement for the refund. Therefore the £30,000 became taxable because it was paid as part of a termination payment and without any mention in the compromise agreement.
The decision is an important reminder that, even where the tax treatment appears straightforward, employers and employees should seek legal advice in relation to the tax consequences of termination payments. It also demonstrates the need to obtain good legal advice as to the terms included in employment compromise agreements as these agreements should clearly show the reason for each payment.
Benchmark Solicitors can assist employers in providing compromise agreements for employees, and assisting employees in negotiating settlement and signing off compromise agreements and employment termination agreements (also known as employment pay offs).
Paul Rogers, Solicitor, Benchmark Solicitors LLP – 11 June 2012