The upper tribunal has ruled payments made to two Tottenham Hotspur footballers for early termination of their fixed-term contracts were subject to the exemption for termination payments and were not taxable as general earnings.
The decision (UT/2016/0157) upholds an earlier first tier tribunal (FTT) decision that tax and NI were not due on the compensation paid to former England striker Peter Crouch and Wilson Palacios, even though their contracts envisaged early termination by mutual consent.
On transfer deadline day, August 2011, Crouch and Palacios were told by Tottenham that they were surplus to requirements as the club sought to reduce its wage bill. Both players agreed to move to Stoke City and received lump sum payments for the terminations, with Crouch striking a deal for £3m and Palacios receiving a total of £1.5m.
HMRC argued that the payments should be classed as earnings and therefore subject to income tax and NI, but Tottenham claimed the money was compensation for ending the contracts by mutual consent. If Tottenham’s analysis was correct the entire payments would be free from national insurance, and the first £30,000 for each player would be tax-free.
At the heart of the case was a relatively mundane technical point: because the payments were in effect for the footballers not doing their jobs, rather than for doing them, Tottenham argued that they were not from employment.
The upper tribunal (UT) rejected HMRC’s appeal and upheld the earlier FTT decision that the payments were not general earnings.
“If HMRC were right that any contractual provision allowing early consensual agreement for a termination is sufficient to make the termination payment made under the resulting agreement 'from an employment', that would cover almost every termination payment agreed in respect of a fixed term contract, because there is nearly always going to be an express or implied right to agree an early termination,” stated Sir Geoffrey Vos and Judge Tim Herrington.
“Although the background to the payment may be the employment contract, the payment itself is not from the employment, but rather in consideration of the termination of the employment,” the judges continued. “If the payment is an agreed payment in lieu of notice paid in pursuance of an express term, that is a different matter.”
A payment in lieu of notice (PILON) is a payment made when an employment is terminated without giving the employee as much notice as they are entitled to under the terms of their contract.
Helpful clarification, but benefits may be short-lived
According to employment tax expert Chris Thomas, legal director at Pinsent Masons, while the judgment is a “helpful clarification”, its significance may be short-lived.
“It’s a useful precedent in a fairly limited number of cases,” Thomas told AccountingWEB. “If you’ve got employees on fixed-term contracts where that contract is terminated before originally envisaged, it’s going to be relevant.”
HMRC had been trying to assert that because the contract envisaged the possibility of early termination [as was the case with Crouch and Palacios], that was enough to mean that effectively the payment received was pursuant to the contract and therefore taxable as earnings from the employment, even though actually the contract didn’t specify that the employee will get a specific sum of money.
“In this case,” said Thomas, “it was the mere fact that the contracts said the parties could agree to terminate early, but it hadn’t said ‘in that situation we’ll pay you the balance, or x amount of money as a PILON’ – it hadn’t gone that far.”
One practical point arising from the judgment is that although on the face of it the judgment looks helpful, its benefits may be fleeting because the government has changed the rules on termination payments in F (no. 2) A 2017. From April 2019, employer's national insurance contributions (NICs) will be charged on ex gratia termination payments over £30,000.
“While the case might be helpful historically for anyone that has a dispute with HMRC,” said Thomas, “going forward it might be of limited practical help.”
NICs trip hazard
According to Thomas, a wider point is that likely to trip up a lot of employers is the NICs treatment of termination payments.
The government recently announced it was deferring the National Insurance Contributions bill that, amongst other things, was going to make changes to the taxation of termination payments. However, what hasn’t been widely publicised is that the application of NICs to deemed PILON payments is still going to happen from April 2018.
“What has been delayed is applying NICs to ex gratia termination payments in excess of £30,000,” said Thomas. “When you pay a termination payment of more than £30,000, at the moment you pay income tax on the balance over that £30,000 threshold but you don’t pay NICs on any part of that termination payment. The proposal is that you will pay NICs on the amount of the termination payment which exceeds £30,000.
“That’s been deferred until 2019, but as far as we can see the application of NICs to deemed PILON payment is not. Because it’s dealt with in separate legislation it’s not going to be deferred so you’ll have income tax and NICs on the deemed PILON which will effectively wipe out the benefit you might have otherwise got from this case.”
It remains unclear whether HMRC will seek to appeal the UT decision to a higher court, but Thomas told AccountingWEB that he would be surprised if they did.
“It was a fairly clear and robust judgment which upheld what the lower tribunal had said, so I’m not sure HMRC would see it as a priority,” said Thomas.
“There’s not going to be a huge amount at stake going forward, but what I don’t know is how much might be riding on it historically in existing cases, which HMRC might be more interested in, so you never know.”
About Tom Herbert
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