What not to put in the letter
Whilst you may believe that the final payment to an employee is tax-free, this must be made clear to the Taxman. A recent case shows what happens when things aren’t clear cut. What lessons can be learnt from it?
Looking carefully at the letter
Termination payments can be a benefit from a £30,000 tax free exemption. Rule of thumb. Damages for breach of contract e.g pay in Lieu of notice will benefit from the exemption but contractual payments will not, resulting in a tax and N.I bill for the employee, with employers’ NI on top. However this is not always clear cut..
Case Law. The importance of the exact used in a termination letter was considered in Redundant employee v McNally (HMIT) SpC400. So what lessons can be learnt?
Date of termination.
The employer stated that the employee’s employment was terminated with immediate effect on September 24th, the date of the termination letter and the date on which the employee handed in her security pass, mobile phone and laptop. The taxman , however, said that her contract expired later, on 23rd December, at the end of the three month garden leave period stated in the termination letter.
Most of the disagreement turned on the termination letter. The first paragraph stated that the employment was terminated “with effect from today”. However, the third paragraph stated that her pay in lieu of notice would be paid monthly through the payroll.
Further, the third paragraph stated she would not be required to attend the office but had to be available for work if required.
The decision was……
The Special Commissioner found that: (1) in spite of the words in paragraph one, an ordinary and reasonable employee could not have understood the company had terminated the contract with immediate effect and without notice, when paragraph three referred to the contractual notice period; (2) by stating that the employee was required to be available for work during the notice period the company was enforcing the contract rather than breaking it; (3) the words “pay in lieu of notice” could support either construction although they are less apt in the context of continuing monthly payment.
Gardening is taxable
No complaints. The ability of the company to put the employee on garden leave was a term of her contract. Yes, it was a discretionary right, but the point of including such a provision was right if exercised, the employee could not complain. The employee agreed to take garden leave by signing the termination letter. So the payments she received from October to December were not compensation for breach of contract but salary whilst on garden leave.
Luckily you can avoid this happening to you by taking some simple steps.
- Keep the termination letter short and to the point.
- Remove the employee from the payroll immediately and issue a P45.
- Remember that so called “garden leave” is taxable for you and the employee, so think twice about formally insisting on any attendance at the office after termination.
Keep termination letters nice and simple so that the taxman can’t interpret them. Take the employee off the payroll immediately and remember that garden leave is taxable salary not part of a compensation package.
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