Richardson v Delaney - Inland Revenue Approach Means Pay-Off Tax Concession Lives to See Another Day

The Inland Revenue has now clarified its treatment of the £30,000 tax exemption, following uncertainty caused by the case of Richardson (HM Inspector of Taxes) -v- Delaney ([2001] IRLR 663). Some commentators have interpreted the case as drastically reducing its availability, but the Revenue has now confirmed that its practice in this respect remains unchanged.

The issue

Where employer and employee reach an amicable parting of the ways, they sometimes agree to terminate the employment contract without implementing either party's right to give notice (and without exercising any contractual right to make a payment in lieu of notice or "PILON"). Because termination results from agreement, there is no breach of contract, and no right to compensation for lack of notice. Instead, the employer makes a payment to induce the employee to give up his rights under the contract, including his right to receive notice. This allows the employee to leave without the stigma of dismissal, and leaves the employer with restrictive covenants intact (because it has not breached the contract) and no exposure to dismissal claims (because there is no dismissal which could be unfair or wrongful). The employee may also agree to waive any other claims he has as part of the agreement.

Existing Inland Revenue practice

A payment which has its source in the contract of employment is fully taxable as an "emolument" from the employment. Thus a payment exercising a contractual obligation or right to make a PILON (or pursuant to an expectation or custom that a PILON be made) is fully taxable. In contrast, where the source of the payment is an agreement reached as part of the termination process (and the payment is not settling a pre-existing contractual entitlement), the Inland Revenue had always allowed the £30,000 tax exemption to apply to the termination payment.

The £30,000 tax exemption is also applied to damages for breach of contract. Caselaw has also established that where an employer has a discretion under the contract whether to make a payment in lieu, it is open to the employer to choose not to exercise the discretion and to terminate without notice, thereby breaching the contract - in that case any pay-off subsequently agreed will be damages for breach (Cerberus Software Ltd v Rowley [2001] IRLR 160).

Facts in Delaney

Mr Delaney's contract could be terminated by 18 months' notice or a PILON, at the option of the employer. In fact, he was given notice and then...