DB ‘termination compensation’ payment are taxable

Cash payments made to Scottish and Newcastle employees to placate them over the loss of their defined benefit pension are taxable, the Court of Appeal finds.

SNR Denton said the decision highlighted the need for employers to consider all the reasons behind why a termination payment was made when deciding if it is taxable.

The ruling in Kuehne + Nagel Drinks Logistics Ltd v HMRC came after both S&N and its employees challenged the taxman on its decision to tax the £4,800 payments.

Payments were made to 2,000 staff of KNDL - the joint venture set up by S&N and Kuehne & Nagel - when their DB benefit accrual ceased.

The compensation payments were made after threats of industrial action. However, HMRC deemed the payments taxable as employment income rather than tax-free termination payments.

S&N and the employees then brought the legal challenge.

The Court of Appeal decided (upholding earlier decisions of the First Tier and Upper Tribunals) the payments were paid and received as an incentive to work willingly and without industrial action and so taxable.

SNR Denton explained the fact that they were also paid and received as compensation for the loss of pension rights on termination of employment with S&N did not prevent this finding.

The law firm said: "The court's decision serves as a useful reminder of the importance of considering all the reasons for which a payment is being made when deciding whether it will be taxable as employment income. If a substantial reason for the payment is that it is to be an inducement for continued services, the payment will be taxable employment income even if there are other reasons for the payment.

"There is a particular risk that this will be the case where a payment is made to secure continued good industrial relations on the sale of a business or company. Sometimes, it may be possible to split a payment into two parts, one a non-taxable compensation payment and the other taxable as employment income. However, it should be borne in mind that HMRC and the courts will look at the real purpose of a payment, not just how it is characterised in an agreement."

The law firm added that where the tax position of a proposed payment is uncertain, employers should think about trying to agree the position with the taxman before it is made.

"Alternatively, tax can be deducted and then reclaimed from HMRC by employees. Where a payment is made free of tax in connection with the termination of an employee's employment and is later found to be taxable, in many cases the bill is likely to fall on the employer, as it will be impossible or cost-ineffective to recover the amount from the former employee," a briefing note added.