Redundancy payments – Deduction for tax
In the current climate, the possibility of redundancies is a regrettable consequence of the pandemic.
Employers need to be aware of the rules surrounding tax relief for payments made during the redundancy process.
This article considers the tax deductibility of payments made. It is also essential that employers considering this move undertake the necessary steps under Employment Law. This topic is not considered here, and professional advice should be sought by the employer.
The rules surrounding the allowability of payments made in redundancy can override the general principles of wholly and exclusively.
It is necessary to consider the deduction under specific rules for deduction and under more general rules,
Under the specific rules, there are two types of payment to consider being Statutory Redundancy Payments and any additional payments made to redundant employees.
Statutory Redundancy Payment
Firstly, we consider Statutory Redundancy Payments.
The Employment Rights Act 1996 sets out the conditions that must be satisfied before statutory redundancy payments are made. In particular, the employee must have been continuously employed for a period of two years and made redundant, broadly speaking, because the business is ceasing or the requirements of the business have altered in such a way that kind of work carried out by the employee is no longer needed.
Employees may also be disqualified from claiming redundancy payments if they are entitled to payment of a pension deriving from the employment within 90 weeks of the redundancy.
Although directors are not specifically excluded, it is arguable whether they are in fact covered by the Employment Rights Act. That said, where a company ceases to trade, statutory payments are in practice made to directors in relation to services performed as employees under contracts of service (whether written or not). It can be accepted that a deduction under these rules applies to such payments in the usual way.
In cases where there is a contractual right to a redundancy payment, a deduction is available to the extent that the payment does not exceed that which would have been payable under the rules for Statutory Redundancy Pay.
Secondly, additional payments are regularly made to employees in a redundancy situation.
A statutory deduction is allowable for additional payments to redundant employees, up to a maximum of three times the amount of the statutory redundancy payment (or, where an approved contractual payment is made, three times the amount that would have been due if a statutory redundancy payment had been payable). For example, if the statutory payment is £1,000, additional payments may be deducted up to a maximum of £3,000.
There are conditions for the relief to be due.
Firstly, there must first be entitlement under law to a Statutory Redundancy Payment or a contractual entitlement to redundancy pay.
Secondly, the additional payment would be allowable as a deduction on general principles but for the permanent discontinuance of the trade or part of the trade.
Also, to be considered is the timing of the deduction in computing the taxable profits (or losses) of the employer.
If the right to a tax deduction is dependent on the rules considered above, then it is given for the period of account in which the payment is made.
Where the payment is made after discontinuance of the trade (or part of the trade) it is regarded for this purpose as made on the last day on which the trade or part trade is carried on.
Turning to the general rules, various points must be considered.
Firstly, and probably most importantly, the specific rules should be considered in the first instance. The general rules will only apply to payments not covered under the specific rules.
On general principles redundancy payments will be allowable as deductions provided that they are paid wholly and exclusively for trade purposes, and do not result in the trader acquiring assets or rights of a capital nature.
Case law has identified a number of circumstances in which redundancy payments may not be incurred wholly and exclusively for the purposes of the employer’s trade.
Of particular interest here are payments in excess of an employee’s pre-existing contractual or statutory entitlement made for the purpose of closing down or selling off the trade. However, this excludes payments made to employees under a pre-existing contractual or statutory obligation. Such excess payments may not be made wholly and exclusively for the purpose of the employer’s trade and, as such, not deductible.
When payments are influenced by family or private interest as may be the case in the single director owner managed business, then a deduction may not be allowed.
From time to time payments are made in conjunction with employees’ undertakings as to their future conduct, for example restrictive covenants. These may be capital expenditure but are allowable if the employee is chargeable to income tax on the receipt.
The taxation aspects in the hands of the employee will be considered in a separate article.
John Riseborough, tax consultant at Vantage Fee Protect