Tax treatment of termination payments in 2009

Termination payments are payments made when an employment ceases. It's a key area for Revenue challenges and may be of increased importance given the current economic climate. The key issue is whether termination payments are taxable:

as earnings or

only under s.401 ITEPA (formerly s.148 ICTA) For the employee the latter classification is much more beneficial as the first £30,000 is exempt. So where do Revenue challenges commonly arise? HMRC tends to leave redundancy payments alone, even if these are increased above the statutory entitlement, provided that they are referable to the statutory formula and can genuinely be shown to have been paid to ease hardship. One of the main areas is where payments in lieu of notice or "PILON" are made. The key distinction as regards PILONs is between payments made under the contract itself, which are taxable, and payments made as damages for breach of the employment contract, which are not taxable as earnings but are compensation for a breach of contract. Where the contract is ended by mutual consent, and a payment is made by the employer, who has a right to make a PILON, the amount will be taxed as earnings because it is paid under the contract rather than as damages for breach of contract. If you're in this position and want to avoid the payment being taxable where there is a provision for an employer to make a discretionary PILON payment, the solution is to terminate the employment in breach of contract and without agreeing to pay anything before settling the damages.