Payments in Lieu of Notice - Payments in lieu of notice raise complicated issues for the employer, as Ray Chidell explains.

Payments in Lieu of Notice
Payments in lieu of notice raise complicated issues for the employer, as RAY CHIDELL explains.
The whole question of notice periods can prove quite a headache for employers, not least when drafting terms and conditions of employment. The subject provides complications from the point of view of both tax law and employment law. Furthermore, an employment contract that is well drafted from the tax point of view may well create employment law difficulties. Nowhere is this more apparent than in the area of payments in lieu of notice.
The concept of a payment in lieu of notice is used to describe several different circumstances. This article focuses on genuine cases of payment in lieu of notice, excluding so-called garden leave and also excluding any cases of actual redundancy, to which different rules are applied.
Contractual or not?
The key issue in considering the tax treatment is to determine whether the payment in lieu of notice is made under the terms of the contract of employment, or whether it is made by way of compensation for breach of the contract. The former will apply where the contract states 'we will give you three months' notice or, if we do not do so, we will make you a payment in lieu of notice'. The contract itself recognises the possibility of a payment in lieu of notice and the payment is therefore not in any sense for breach of contract. Therefore it is taxable under the normal rules of Schedule E (see section 19, Taxes Act 1988).
The position is very different if the contract states simply 'we will give you three months' notice', but the employer decides instead to make a payment in lieu. In this case, the employer is in breach of the terms of the contract of employment and the payment is therefore by way of compensation for that breach. It is not caught by section 19, but will normally fall within the terms of section 148, with the distinction that the first £30,000 will be tax-free.
If that were the end of the story, life would be simple. Remove all reference to payments in lieu of notice from the contracts of employment and all would be well. Inevitably, there are complications.
First, such an approach may well be a jump out of the tax frying-pan into the employment law fire. If the employment contract states only that notice will be given then, as indicated above, the payment in lieu of notice will be a recognition that the employer is breaching the contract. In doing this, the employer may find that the edifice of protection built into the employment contract tumbles around him. For example, the contract may contain restrictive covenants about non competition after the employee has left. It may well be that in breaching the contract, the employer gives up the protection that would have been afforded to him in this way.
Implied employment contracts
This can lead to some difficult decision-making about the way employment contracts should be worded: should they be driven by tax or employment law considerations? Furthermore, even if the employment contract does not specifically recognise the possibility of a payment in lieu of notice, the Revenue may well argue that such a possibility is implied. Typically the Revenue will refer to a very old tax case, Corbett v Duff 23 TC 763, where certain payments were held to be chargeable under the then equivalent of section 19 because 'the payments though not obligatory are expected, are generally asked for and are usually accorded'. The Revenue may also refer to the Court of Appeal judgment in EMI Group Electronics Ltd v Coldicott [1999] STC 803, which EMI lost.
Arguably, the Revenue sometimes seeks to push these principles further than it can legitimately. A case with which the writer has recently been involved concerns an agreement with a trade union reached just months before redundancies were made. The Revenue, with a less than complete appreciation of the full facts, started to argue that this agreement meant that the payment in lieu of notices would be taxable. It appears that the reality is that the trade union agreement was reached precisely as part of the redundancy process. In the EMI case, reference was repeatedly made to contractual provisions agreed at the outset of the employment, to a bargain made at the commencement of the employment and to how a prudent employee enters into employment on particular terms. The clear implication is that the Revenue case is much weaker unless there is an actual or implied agreement at the start of the employment to make a payment in lieu of notice in certain circumstances. The EMI case was never an easy one for the company to win. It will be interesting to see whether the Revenue has the stomach to risk diluting its success in that case by arguing a new case on the basis of a merely implied agreement, particularly if that implied agreement only came into existence after the employment had started.
Notice periods
It is easy for an employer to forget that employees have statutory rights to a notice period that may well exceed the period referred to in the contract of employment. Under the Employment Rights Act 1996, employees have an entitlement to a minimum notice period, based on length of service. The general rule is that an employee is entitled to not less than one week's notice for each year of continuous service, up to a maximum of 12 weeks for 12 or more years. Different rules apply for the first two years and care is needed with short term, temporary or fixed term contracts.
Ray Chidell is a tax partner at Mazars Neville Russell. For further advice, contact Ray Chidell or Graham Hole on 01273 206788; e-mail: ray.chidell@mazars-nr.co.uk. Mazars Neville Russell has produced a free factsheet dealing with employment law and best practice in relation to notice periods. To obtain a copy, contact Vicky Williams on 020 7220 3251. Ray also produces fortnightly employer tax bulletins available free of charge by e-mailing: ETU@mazars-nr.co.uk.
 

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