A termination payment is taxed by default under TCA 1997 s 123, and TCA 1997 s 201 goes on to allow a tax-free termination payment of €10,160 increased by €765 for each complete year of service of of the holder in the office or employment in respect of which the payment is made.
The use of the word "office" means that office-holders such as director can potentially get the exemption.
The basic exemption (€10,160 + €765 for each year of service) may be further increased by the lower of:
- €10,000 if you have not claimed relief in excess of the basic exemption in the preceding 10 years, and
- the difference between €10,000 and the payment amount where the lump sum pension commutation payment to which you are entitled on retiring does not exceed €10,000 (but if the pension commutation payment exceeds €10,000, the increase to the basic exemption is limited to €10,000).
You receive a termination payment of €100,000.
You have has been with the company for 20 years.
Your basic exemption is €25,460, which is calculated as €10,160 + (€765 x 20).
At retirement date, you will become entitled to a pension, and it is estimated that the current value of the lump sum commutation payment you can take will be €7,000.
Therefore, your basic exemption can be increased by a further €3,000 (€10,000 - €7,000) to €28,460.
If you are entitled to a pension on retirement, you may be entitled to further relief if the amount of your standard capital superannuation benefit (SCSB) exceeds your basic exemption. Your SCSB is calculated as:
- one-fifteenth of your average yearly emoluments for your last three years of employment (or the whole period if less than three years) before your departure date, multiplied by
- the whole number of your complete years of service,
- less the relevant capital sum, i.e., the present value of your right to opt, at the time you become entitled to receive your pension, to take part of the pension as a tax-free lump sum.
If your SCSB is greater than your basic exemption, you get a further exemption for the amount by which the SCSB exceeds your basic exemption. In other words, your SCSB figure can replace your basic exemption figure.
So far so good.
Is the termination payment in lieu of salary? if it is, it is not exempt.
Is the company ceasing to trade - and "terminating" its primary income earner? If so, Revenue could argue that the termination payment is not incurred "wholly and exclusively" for the purposes of the trade or business and deny the deduction at 12.5%. This is not a strong argument as it is normal and tax-deductible for companies to pay redundancy to departing staff.
Could Revenue take the view that a termination payment is a disguised distribution and taxable under Schedule F in the hands of the recipient - and subject to dividend withholding tax (25%)? They could. In my view this would be an uphill struggle for Revenue if the termination payment is reasonable and in line with what would be payable to non-proprietary directors.
In these situations, if there is a significant risk of protracted conflict with Revenue, it might be advisable to extract the funds via liquidation and pay CGT if required.
Written by Alan Moore
Founder and CEO of Tax World Ltd