27 JUN 2016
Tax treatment of payments arising out of a termination by mutual consent
Solicitor, Veale Wasbrough Vizards
Does a 'termination by mutual consent' clause change the tax and NIC treatment of a payment made under a settlement agreement?
In 2011, Tottenham Hotspurs Football Club (Spurs) wished to reduce its wage bill as its commercial income had declined. Peter Crouch and Wilson Palacios (the players) were employed by Spurs under fixed term contracts. The contracts contained a clause which confirmed that they could be terminated early by mutual consent.
The players were contractually entitled to remain at Spurs until the expiry of their respective fixed term contracts and be paid in full for the duration. However, in doing so, they would be unlikely to be selected to play and would consequently lose match fitness, appeal to rival clubs and the potential to be selected for their national teams. From Spurs' perspective, they would not succeed in reducing their wage bill. The parties therefore agreed to terminate the contracts. The players each received a significant payment from Spurs in exchange.
So, what’s the issue?
If the payments were 'earnings', they were subject to deductions for tax and NICs. If the payments were compensation, no liability for Class 1 NICs arose at all and the players were able to receive £30,000 free from tax in accordance with current tax legislation.
HMRC determined that the payments were earnings because the terms of the players' contracts provided for early termination by mutual consent and therefore any payment received in consequence of implementing those terms was from the employment.
The First-Tier tax Tribunal (the tribunal) had to decide: were the payments 'earnings' or were they compensation as asserted by Spurs?
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And the result?
The tribunal found that, on the facts, the payments were compensation for the surrender of rights. The tribunal pointed out that the inclusion of a mutual consent clause did not change the legal position: all contracts can be terminated by mutual consent whether this is explicitly stated or not.
The tribunal also found a breach of contract is not necessary in order for a payment to be regarded as compensation for the surrender of rights.
The case makes it clear that an employee's involvement and agreement to the termination of their employment does not determine the tax and NIC treatment of any termination payment. It will still be necessary to consider all of the facts and the reason for the payment. If there is a 'sufficiently substantial' employment-related reason for making the payment, the payment may be earnings, even where there are other important motivating factors for making or receiving the payments, as in this case.
Employers should note that, as confirmed in the Budget 2016, the current exemption from employer NICs on termination payments will be abolished. From April 2018, employer NICs will be due on those payments above £30,000 that are already subject to income tax. However, the full termination payment will remain outside of the scope of employee NICs.