Question of the Week - Does the ￡30,000 tax-free exemption always apply to compensation payments made at termination of employment?

Surprisingly for some, the answer is no. Simply because a payment is made upon termination of employment does not mean that it will automatically qualify for the ￡30,000 exemption.

Contractual payments made on termination of employment are always subject to tax and national insurance contribution deductions, even if they are expressed to be paid as compensation for loss of employment, or an "ex gratia" payment. Some caution should therefore be taken about discussing exit packages a number of months in advance - if a commitment (or promise) is made it could become a contractual payment

Termination packages can consist of many different elements, and the tax treatment will depend on the reason for the payment. You need to determine the reason for each element of the termination payment - accrued holiday pay, bonus payments or pay in lieu of notice will all be taxable.

The ￡30,000 tax-free exemption generally applies to the part of a payment that is compensation for loss of employment only. It would not apply where the payment is a payment for entering into a new restrictive covenant, payment in anticipation of retirement or a reward for employment service. These payments are subject to deductions of income tax and national insurance contributions.

You may also be familiar with the term "PENP" - which is a post employment notice pay. Any element of a termination payment that represents an unworked part of notice,?irrespective of whether or not there is a contractual payment in lieu of notice clause in the contract, is regarded as PENP and therefore fully taxable.

There are some occasions when a compensation payment can fall outside of scope of income tax national insurance contributions act completely. This is where compensation is for injury to feelings due to alleged discriminatory acts prior to termination of employment. Revenue clearance should be sought in these circumstances.

It is also worth noting that in addition to the ￡30,000 tax-free exemption, the employer can pay the employees legal costs tax-free provided the costs are incurred exclusively in connection with the termination of employment, and payment is made either subject to a court/tribunal order or a settlement agreement. Employer contributions to registered pension schemes may also be tax-free subject to the annual and lifetime allowances.