By Pat Sheehan & Karen McEntee
A shortened version of this article was published in the Limerick Leader, Saturday 4 July 2009

Unfortunately, due to the current economic climate, there has been an increase in the number of employers in the Limerick region asking for advice regarding redundancies and termination payments.  We have also seen an increase in the number of employees seeking advice regarding compensation payments from employers, not just for termination of employment but for issues such as unfair / constructive dismissal etc. In addition to the necessary legal advice, taking appropriate tax advice of signing a Settlement Agreement could substantially reduce or even eliminate the tax liability associated with the payment.     

Correctly framing the agreement can ensure that recipients obtain the tax reliefs or exemptions that they are entitled to.  The recipient of a compensation payment could be liable to Income Tax, Capital Gains Tax or even Capital Acquisitions Tax on the payment received.  There are however, certain exemptions available which are described in the table below.

In addition, in certain cases, the person making the compensation payment may be obliged to operate PAYE on the payment.  Failure to do so can give rise to serious financial implications for the payer. 

Compensation Payments

Below are set out some general observations about compensation payments:

• It is necessary to examine the exact nature of the payment to determine the tax treatment.  It should never be assumed that a compensation payment will be exempt from tax. 
• If the payment is made on foot of a court case, out of court settlement or otherwise, the Revenue Commissioners may ask to see the relevant legal and supporting documents, when reviewing the tax treatment of the payment.
• Tax advice should always be sought before signing a Settlement Agreement.
• While “pure” compensation payments would not normally be liable to VAT, any agreement signed should be carefully drafted to ensure VAT does not arise or is properly dealt with.

Termination Payments

Below are set out some general observations about termination payments:

• Tax planning opportunities are available where, for example, an individual steps down as a director but continues to remain on as an employee or perhaps where a director or employee changes the nature of their duties/functions.
• If a payment is made as part of a contractual obligation in the employee’s contract, then it must be taxed as salary and no exemptions/reliefs are available.
• Compensation awarded by the Labour Court for unfair dismissal or by the Employment Appeals Tribunal (“EAT”) for job loss may qualify for full or partial exemptions.  However, an EAT award for loss of earnings is fully taxable.   
• Part of the payment up to a maximum of €5,000 may be exempt if it relates to re-training and meets certain conditions.

In conclusion, failure to obtain professional tax advice before the Settlement Agreement is signed can give rise to significant tax costs which could potentially have been avoided or taken into account in the negotiations. 

We are all aware of the economic challenges facing Ireland and unfortunately Limerick is not immune from this. The Limerick region has already experienced large scale redundancies. Managing this process correctly from both employers and employees perspective is very important. We would therefore strongly urge both payers and payees to obtain appropriate tax advice in such cases. From our experience locally one area which employers need to pay particular attention to is statutory redundancy entitlements, notice periods etc. Not applying the correct procedures can lead to penalties etc, a cost which most employers could do without!