Government to look at income averaging in context of redundancy payments

The Bill, which completed its passage through the House of Commons earlier this month, will introduce a limited class 1A employer charge on termination payments over £30,000 and on payments over £100,000 related to non-contractual sporting testimonials. The genesis of the Bill was a wide-ranging review by the Office of Tax Simplification in 2013.

Speaking for the Government, Lord Young of Cookham explained that the OTS found relatively few employers and employees properly understood the termination award regime and it had recommended reform. He said the current misalignment between income tax and NICs treatment in relation to termination awards is confusing and incentivises well-advised employers to disguise final payments as compensatory termination awards that benefit from a NICs exemption. Only around one per cent of the workforce will receive a termination award in any given year, and of these around 80 per cent will be unaffected by the Bill, the peer said.

Lord Young – who was Financial Secretary in John Major’s government in the 1990s – commented on the Opposition’s proposed new clause that would have require the Government to report every two years on the impact of the changes to termination awards on the number and size of awards, as well as any effect on specified groups with protected characteristics. The Government had already assessed the impact of the policy under the Equality Act 2010 and the conclusions were published as part of the TIIN, he said, explaining that the assessment had found no disproportionate impact on any of the groups specified in the proposed new clause. ​He also noted that, since 2017, if not further back, the Government had received no representations from stakeholders regarding any disproportionate impact on protected groups.

Lord Young said the changes to rules governing sporting testimonials were now changing to give clarity to the NICs treatment. Following a consultation, the Government increased the tax-free threshold from £50,000 to a ‘very generous’ £100,000. He expects the impact on charitable donations to be minimal, since donations made from sporting testimonials via payroll giving, operated by independent sporting testimonial committees, will not be subject to any income tax or NICs at all. HMRC estimates that there are only around 220 testimonials each year, with an average taking of around £72,000, he added.

For Labour, Lord Tunnicliffe has concerns that the introduction of additional employer NICs may act as a disincentive to responsible employers who want to top up statutory redundancy payments in recognition of an employee’s contribution to the firm. In general, the peer wants consideration given to how future tax changes can encourage employers to ‘properly look after’ those employees whom they have to let go. He said he was relieved that responsibility for any miscalculations will lie ultimately with the employer and that individuals will not be pursued for them by HMRC.

Turning to sporting testimonials, Lord Tunnicliffe called for a plain English explanation of “non-contractual, non-customary”. He said it would be a shame if an unintended consequence of this measure was to introduce additional barriers for people donating money to charity. He spoke of his concern that the Bill would result in smaller termination awards being made to employees unfortunate enough to lose their jobs.

Lord Macpherson of Earl’s Court, a former Treasury Permanent Secretary who now sits on the crossbenches in the upper House, said that if redundancy payments are subject to income tax, it follows logically that they should be subject to national insurance. A higher tax charge might deter unnecessary redundancies, he speculated. He made a general point that although there would be substantial administrative gains if income tax and national insurance were brought together, and the tax system would become altogether simpler and more intelligible for citizens, governments generally conclude that full alignment is altogether too difficult. He hopes the Bill represents a small step in the alignment direction.

Lib Dem spokesperson Baroness Kramer said the UK’s tax system deals very badly with earnings that spike in one particular year. “Somebody who is made redundant in one year and receives a substantial payment might then not be employed for the next three years,” she explained. “It makes you question whether applying the taxes we do was appropriate in the way that it was attached to that redundancy payment. We do not do things such as income averaging, which other countries use.” Moves towards greater alignment of NICs and income tax are fine, she said, but we have to look much more fundamentally at whether these systems actually work with the way people work and earn their living today. She supports the legislation as long as there will be no move to suddenly apply NICs to the employee.

Closing the debate, Lord Young said the Government has no plans to charge employee NICs on termination awards, or indeed on testimonials. HMRC have evidence that a minority of well-advised employers have been manipulating the rules to minimise their NICs liability, which is a further reason for seeking to bring in this alignment, he said. The government spokesman said Baroness Kramer’s idea for averaging was ‘interesting’: “I would be misleading her if I said that that was likely to happen, but it is an interesting suggestion which we shall take on board and see whether there is an opportunity to spread the receipts.”

Lord Young confirmed that, in the case of any under deduction or underpayment of PAYE income tax by an employer, HMRC is obliged to recover in the first instance from the employer. However, in some circumstances, for example where the employer made an innocent error or the employee knew that insufficient tax had been paid, HMRC may transfer the PAYE income tax to the employee at a later point, he said.

He closed by saying termination payments in the form of redundancy pay are treated as capital rather than earnings and are therefore disregarded as income for universal credit purposes. However, if that payment results in someone having more than £16,000 in savings, they would no longer be eligible for universal credit. He was quick to add that the Bill will not negatively affect a household’s universal credit entitlement, because earnings for universal credit are considered net of income tax and NICs.

The full debate can be read here.

By Hamant Verma