Is PAYE applicable to separation settlement payments?

COURTNEY MCNISH

This article is intended to clarify these complex issues related to the applicability of taxation on payments to employees regarding separation settlements and ex-gratia awards.

Under Section 5(1) (e) of the Income Tax Act Chapter 75:01 (hereinafter referred to as “the act”), tax is payable on gains or profits from any employment or office, including pensions or emoluments within the meaning of Section 100, and any contribution of the employee paid by the employer on behalf of the employee to an approved pension fund or scheme.

Emoluments are defined in Section 100 of the act as all salary, wages, overtime, bonus, remuneration, perquisites including the value of board and lodging, stipend, commission or other amounts for services, directors’ fees, retiring allowances or pension, arising or accruing in or derived from or received in TT and which are assessable to income tax.

However, there is no specific definition of what is considered to be gains or profits from any employment.

Additionally, there is no mention of compensation for loss of office. Given that there is no definition or mention, it can be argued that a separation settlement payment is not a gain or profit, but rather a capital payment made in exchange for the loss of employment, and therefore not subject to taxation.

The common-law jurisprudence states that where payment for compensation for loss of office is made to an employee in exchange for the surrender of employment, this payment would not be taxable, as it could not be considered to be a profit gained in respect of employment, but rather a capital receipt or an amount received as compensation on surrendering a right.

In Henley v Murray (HM Inspector of Taxes) (1949) 31 TC 351, the relevant payment was made following a compromise of a potential dispute that the parties agreed between themselves. The Court of Appeal drew a distinction between the “receipt of remuneration or profits in respect of the office” and “sums paid in consideration of the surrender by the recipient of rights in respect of the office.” It was held that the sums paid were not taxable.

Conversely, in EMI Group Electronics Ltd v Coldicott (1999) STC 803, where a payment made in pursuance of a contractual provision, agreed at the outset of the employment, which enabled the employer to terminate the employment on making that payment, was held to be remuneration in respect of the employment. even though it was made in conjunction with the termination of the employment.

Such a payment is not paid in consideration of the recipient’s “surrender of rights” under the contract, because the recipient is receiving what was bargained for under that contract and therefore taxable.

Further, in the case of GCT v Comptroller of Income Tax (2020) SGITBR 3 the Income Tax Board of Review rejected the long-standing position taken by the Comptroller of Income Tax that ex-gratia payment provided for in an employment agreement would be subject to tax.

Instead, the board addressed the key considerations of establishing the characteristics of the termination payment, regardless of how the payment is termed, in determining whether it can constitute a payment for loss of employment or restrictive covenant. A payment for loss of employment or restrictive covenant is regarded as capital receipt (ie any amount received as compensation on surrendering a right) and not subject to income tax.

In arriving at its decision, the board emphasised the importance of anchoring the analysis for tax treatment of the severance payment on the taxing statute, ie, the Income Tax Act (Cap 134) (the English Act).

The board highlighted that it is important to look beyond how the payment is termed but into the true characteristic of the payment to determine whether the payment, in this case, falls under the ambit of section 10(2)(a). Similarly, the board was of the view that whether or not a payment is specified in the employment agreement is a factor, but is not conclusive in determining its nature.

Under section 10(1)(b) of our act, gains and profits from employment are assessable to tax. Section 10(2)(a) further defines the following nine categories of payments as falling under “gains or profits from employment” – “any wages, salary, leave pay, fee, commission, bonus, gratuity, perquisite or allowance...”

In order for a receipt to qualify as “gains or profits from employment,” the character of the receipt (regardless of its term) has to fall strictly within the definition of any of the nine categories of payment identified in section 10(2)(a).

These categories refer to payments made in recognition of past, present and future services performed. The provision does not list what falls outside “gains or profits from employment.” In particular, it does not cite redundancy payment or compensation for loss of office. Consequently, payments for redundancy or compensation for loss of office would not constitute gains or profits from employment and therefore not subject to PAYE.

This general thinking was followed in Civil Appeal No 101 of 2006 Winston Barrow v the Board of Inland Revenue, where an employee was paid a sum representing compensation for his loss of employment and for his unused vacation leave when his employment contract was terminated by his employer. The court held that the portion paid to the appellant representing the compensation for his loss of employment was not taxable, as the employee’s employment had ceased, and it could not be considered to be emoluments under section 100 of the Income Tax Act.

Notwithstanding the positions articulated here, I must confess I am not a tax expert, and HR managers are advised to consult with their auditors and more qualified people so as to ensure no tax liability burden is placed on the company’s shoulders when making such payments.