02 June 2011

HMRC does not intend to amend the new regulations allowing an employee's legal costs on termination to be paid by the employer free of tax, despite the new regulations being narrower than the previous regime.

Pinsent Masons reports the following:

An extra-statutory concession allowed an employee's legal costs to be paid by the employer free of tax if they were either ordered to be paid by a court or tribunal or, if paid direct to the employee's lawyer under the terms of a compromise agreement. This concession was recently withdrawn and formally enacted into legislation by theEnactment of Extra-Statutory Concessions Order 2011. The Order affects payments made on or after 6 April 2011.

It waswidely acknowledgedthat the Order was narrower in scope than the extra-statutory concession – as drafted, it only applies where the settlement agreement complies with the compromise agreement provisions under the Employment Rights Act 1996 (ERA). Therefore, on a strict interpretation, there was concern that the tax concession no longer applied in cases involving a COT3 agreement reached with the help of Acas, or a compromise agreement which only referred to legislation such as the Equality Act 2010.

HMRC initially announced that it would look into the issue and if necessary, seek an amendment. HMRC has now confirmed that the Order will remain as enacted and that the regulations will not be amended. HMRC has said, however, that the exemption is not limited to agreements that compromise claims under the ERA but applies to all agreements that satisfy the ERA compromise agreement conditions.

In practice, there is still concern that COT3 agreements reached through Acas conciliation may not be able to be used to obtain the benefit of the tax exemption. We are seeking clarification from HMRC about this. In the meantime, employees may find some comfort from HMRC's statement that its intention is not to penalise employees.