The Special Commissioners, in a decision given on 23 May 2006 in the case SCA Packaging Ltd v The Commissioners for HM Revenue & Customs, ruled that, where a redundant employee agrees to leave on short notice, the payment in lieu of notice, as set out in the employee's contract, is made in respect of the employment and is therefore taxable in full.

The appellant in this case, SCA Packaging, had made a number of employees redundant over the period 1996 to 2001. The termination payments generally included a payment in lieu of notice, from which the appellant did not deduct PAYE tax and NICs unless they exceeded £30,000. HMRC had assessed unpaid tax and NICs at around £70,000 and SCA Packaging was appealing against that assessment.

The written decision is long and detailed but may be summarised as follows:

• Although the employer's provisions on how short notice in the event of redundancy would be handled were set out in a separate Memorandum of Agreement, those provisions were incorporated into each employee's contract of employment because they touched directly on the relationship between employer and employee.
  
  
• The redundancy terms set out in the Memorandum of Agreement specified that, on termination for redundancy, a payment would be made in lieu of any unexpired period of notice and defined the formula that would be used for calculating the amount of the payment.
  
  
• As these terms were an integral part of the redundancy payment provisions, they could not be viewed as a payment of damages for breach of contract. The payments were made in performance of the contract, not in breach of it.
  
  
• If the contract states, as did SCA Packaging's contract, that an employee "will" be entitled to a period of notice or pay in lieu of that notice, the payment is contractual, not for breach of contract.
  
  
• On the other hand, if the contract states that an employee is entitled to a period of notice but the employer "may" pay in lieu of that notice, the employer may choose whether to
  
  
  • apply the contractual terms and make a payment in lieu of notice, or
    
    
  • ignore the contractual terms and make a payment of damages for breach of contract, subject to the employee's duty to mitigate the loss.
    
    

• The fact that a contract contains specific provisions for redundancy notice and payment does not provide a right for the employer to terminate on short notice. The employer may seek the employee's agreement to go on short notice, but the redundancy provisions only apply if the employee agrees. If the employee agrees, the existing contract must be treated as having been varied.
  
  
• If the payment in lieu is made under such a variation of the original contract, any part of the payment that derives from the agreement to go on short notice stems from the employment (as opposed to resulting from the termination) and is, as a result, taxable in full.
  
  
• Where there is no right to redundancy payments under a contract, a payment in lieu is not made for the modification of the contract but for the cancellation of it. Therefore, the payment derives from the termination, not from the employment, and is not taxable (unless it exceeds £30,000).
  
  
• The fact that a non-contractual payment in lieu of notice is made habitually does not turn it automatically into a payment deriving from the employment. It does not, in itself, make it "contractual". If an employer habitually makes payments in lieu of notice in circumstances where they derive from the termination, that practice does not turn them into payments deriving from the employment.

The last time HMRC published revised guidance on payments in lieu of notice was in 2003, in an article in Tax Bulletin 63. The article distinguished between payments that were discretionary, paid automatically and paid as damages. The decisions of the Special Commissioners in this new case are not inconsistent in many respects with the guidance already available. However, they do raise further questions on HMRC's approach to payments in lieu of notice, in particular to "habitual" payments and to the reasoning behind taxing payments because they are "contractual". It will be interesting to see how this case prompts a review of HMRC's guidance.

...back to 15 June 2006

Sources:
SCA Packaging Ltd v Revenue & Customs
Tax Bulletin 63

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