The release of the new draft clauses of the Finance Bill 2017-2018 heralds the curtailment of Foreign Service Relief (FSR) for termination payments from 6 April 2018.
The changes to the taxation of termination payments have followed a winding road. It was back in 2015 when HMRC first issued its consultation on whether change was merited. But the issue had, in effect, been live since 2014 when the Office of Tax Simplification (OTS) issued its report on employee expenses and benefits, which considered termination payments among other areas.
Legislative changes were first announced at Budget 2016. Draft legislation was published later that year. However, one of the key areas of contention regarding the draft legislation was the abolition of foreign service relief (FSR) in certain scenarios.
In response to stakeholder feedback, the Government subsequently announced the changes to FSR would be deferred for further consultation. The other termination payment reforms were included in the Finance Bill 2017-19, published on 8 September 2017.
This consultation on the draft clauses amending FSR runs until 25 October 2017.
The draft legislation proposes to remove FSR in cases where the relevant employee is UK tax resident in the tax year that their employment is terminated. However, this proposed change is not extended to seafarers for whom the position on FSR will essentially remain unchanged.
This change would be implemented in April 2018 in addition to the other proposed changes on termination payments which align the tax and employer’s (but not employee) NIC position for payments above £30,000 and provide for non-contractual payments in lieu of notice to be subject to tax/NIC as regular earnings.
HMRC say that FSR is “outdated and unnecessary” and that its abolition will help achieve a fairer tax system. That said, many would still see a role for FSR where individuals have been working for substantial periods overseas. In any event, the tax yield from amending termination payments is estimated at about £1.65 billion over the next five years (albeit HMRC say that only around 1,000 individuals claim FSR each year).
With the exception of seafarers, the proposals can be broadly broken down as follows:
This change will apply where the date of the termination is on or after 6 April 2018 and the payment (or other benefit) is received after 13 September 2017.
Employers, particularly Human Resource directors will need to consider the impact of the new approach on FSR (coupled with the other changes on termination payments noted above).
Points to consider include:
Globally mobile employees
This last point may not be as simple as it sounds as consideration will be required on how the rules will apply where international mobility considerations are in play.
For employers with globally mobile employees, the removal of FSR may not necessarily mean that the whole payment is subject to tax in the United Kingdom.
In particular, where an employee has recently been on assignment overseas, the host location may wish to tax some or all of the payment and the UK may be required to give relief under a double taxation agreement. There may also be dual withholding obligations. It will therefore be important to review cross-border termination cases to ensure that appropriate policies are in place to deal with the consequences.
The draft clauses as they stand also seem to point towards different tax treatments for inbound and outbound assignees, i.e. depending on where they are tax resident in the tax year of termination.
Importantly, as drafted, it is not the employee’s status on the date of termination that is determinative but rather the residence position for the whole UK tax year of termination. An inbound employee to the UK who is terminated after leaving the UK will still be impacted by the withdrawal of FSR where he or she still technically remains UK resident for the UK tax year of termination, notwithstanding split year treatment.
Care will be required.
As mentioned above, the draft clauses are subject to consultation. We will be submitting our comments to HMRC and HM Treasury in due course and will keep you posted.
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