It is often assumed that the tax-free compensation of up to £30,000 for ‘loss of office’, available under s403 (1) of the Income Tax (Earnings and Pensions) Act 2003 (‘ITEPA’) is an automatic right; however the recent decision of the First Tier Tribunal in Simrajsar Ltd v HMRC [2024] has reminded us that this is not the case.
Facts:
Simrajsar Limited and Achilles Products Limited have recently failed in their appeal against HMRC to have various payments made to directors under the guise of ‘compensation for loss of office’ declared free of tax under s403 ITEPA. The case reviews five £30,000 termination payments made to Directors upon their voluntary departure; HMRC issued a Regulation 80 Determination in respect of unpaid PAYE and income tax and a Section 8 Notice in relation to unpaid National Insurance Contributions. The Directors in question did not have any relevant contract of employment or directors service contract in place and received no renumeration for their work, save for two isolated events concerning two of the Directors. In each case, the Directors received £30,000 as ‘compensation for loss of office’ on their voluntary resignation. No indication as to how said figure was agreed was offered, save for a letter from their legal representation stating the amount was ‘fiscally efficient’. The Directors failed to disclose the payment on their respective self-assessment tax returns as it was presumed to be free of tax.
Legally speaking, on behalf of the Directors, it was argued that the payments fall within s401 ITEPA and are exempt under s403; however, HMRC rejected this argument on the basis that payments amounted to retrospective remuneration for their role. Thus, the payments amounted to ‘earnings’ as defined by s62 ITEPA, so could not be exempt under s403. Given the lack of termination/settlement agreement setting out why the payments had been made or indeed how the figure had been calculated there was little the Directors could rely on to bolster their argument. As the directors received no renumeration for their role, they suffered no financial loss on ceasing to act as director, thus HMRC were able to successfully argue that there was no suitable basis for ‘compensation’. HMRC stipulated that any hypothetical ‘compensation’ ought to be calculated as damages and would therefore be offered in exchange for the departing employee releasing the employer from any potential claims. In the absence of this contractual duty and lack of codification there is no scenario by which ‘compensation’ is required, especially as the Directors resigned voluntarily.
Findings:
The Tribunal determined that the payments were ‘gratuitous lump sums paid in recognition of past service’; the payments were deemed ‘earnings’ and thus, subject to income tax under s62 ITEPA. In addition, the Directors’ business was tax related therefore even if they were not tax experts themselves, they would have had easy access to relevant advice from an internal person. A ‘reasonable tax payer in the position’ of the Directors would have sought advice in this regard and it would’ve been wise to do so. In light of this, the Directors failed to take ‘reasonable care’ in declaring their payments therefore the time limit for assessment was extended to six years, enabling HMRC to require the taxable position to be rectified.
Although one may perhaps look at this as an ‘unfortunate’ incident, it is indeed evident that the ‘maximum’ tax free amount ‘raised eyebrows’ with HMRC. This case should stand as a stark word of warning; employers and employees alike should seek appropriate advice, especially when looking to take advantage of any ‘tax exemptions’. Decisions should be documented in a formal agreement and any advice should be recorded so this can be evidenced if necessary. Tax is rarely straightforward and ought to be approached with caution. In light of today’s economy, it is expectable for HMRC to look to recoup as much as possible.
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