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November 2, 2015

Andrew v HMRC – Taxation of Payments in Lieu of Notice

The latest case heard before the First Tier Tribunal highlights the important tax consequences for payments resulting from the termination of employment.

The Facts

The taxpayer was dismissed without notice and entered into an agreement with his former employer under which he received £68,800 for salary and benefits owed during his notice period.

Under the contract of employment, the taxpayer was entitled to six months’ notice but the employer retained discretion to make a payment in lieu of notice (PILON).

The taxpayer received legal advice indicating that the first £30,000 was exempt from tax under section 403 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”).

HMRC did not consider the payment eligible for this deduction.

The Case

The taxpayer contended that he was made redundant and that the payment was made under section 401 ITEPA as a payment for termination. Under section 403 ITEPA, the first £30,000 of such payments are exempt from tax.

HMRC contended the payment was a PILON, taxable under section 62 ITEPA, and not a payment of damages for a breach of contract, which would fall under section 401 ITEPA.

PILONs that flow from an employment relationship are taxable as “earnings” under section 62 ITEPA and are chargeable to income tax. They cannot fall within section 401 ITEPA and are not subject to the £30,000 exemption under section 403 ITEPA.

The Decision

The Tribunal accepted that the taxpayer was made redundant but found the payment was made in lieu of notice. It therefore did not fall within section 401 ITEPA and he could not benefit from the £30,000 exemption under section 403. The whole amount was therefore taxable under section 62 ITEPA.

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