Payments within Section 123
s123 Section 123 brings within the charge to tax any payments made in connection with the termination of an office or employment, or in connection with a change in functions or emoluments of the office or employment. The following conditions apply to the payment:
it must not otherwise be chargeable to income tax (i.e., not chargeable under s112);
it may or may not be in pursuance of a legal obligation (i.e., it may be ex gratia, or a compensation payment which the employer is legally obliged to make);
it may be in the form of valuable consideration other than money (e.g., a car, house, etc.);
it may include a payment in commutation of annual or periodic payments which would otherwise have been made in connection with the termination, or change.
The recipient must be one of the following:
the holder or past holder of the office or employment;
the executor or administrator of the holder or past holder of the office or employment (in the case where the employee has died);
his spouse, or any relative or dependant;
any person to whom the payment is made on behalf of the holder or past holder of the office or employment.
In practice, the section covers ex gratia payments as testimonials on termination of an employment, compensation payments for loss of office or employment, payments as salary in lieu of notice (not being payments under the terms of a service agreement), redundancy payments (in excess of statutory redundancy which is exempt), damages for breach of contract, etc.
s123(4) The payment is treated as income received on the date of termination in respect of which it is made, regardless of when it is paid. A payment in commutation of annual or periodic payments is treated as received on the date on which the commutation is effected.
Exemptions from the Section 123 charge
s201 Section 201 defines certain payments which are excluded completely from the charge under s123 and can therefore be paid tax free. These are as follows:
s201(2) •
payments made in connection with the termination of the holding of an office or employment due to the death of the holder, or made on account of injury to or disability of the holder;
s201(2A) With regard to such payments made on or after 25 March 2005, there is a requirement for the person by whom such a payment is made to deliver to the Inspector of Taxes, not later than 46 days after the end of the year of assessment in which the payment is made, particulars of:
a) the name and address of the person to whom the payment was made,
b) the PPSN of the person to whom the payment was made,
c) the amount of the payment, and
d) the basis on which the payment was not chargeable to tax under s123, indicating in the case of a payment made on account of injury or disability, the extent of the injury or disability, as the case may be;
payment made in connection with restrictive covenants; (assessable under s127);
payments made under pension schemes where the contribution made by the employer was assessed as an emolument of the employee;
s201(3) •
any benefit (e.g., a lump sum payment in part commutation of a pension) under an approved pension scheme, a statutory scheme or a scheme set up by a foreign government for the benefit of its employees, but excluding termination allowances and severance allowances paid on or after 1 November 1992 to outgoing members of the Oireachtas and to former holders of ministerial and parliamentary offices and special severance gratuities paid on or after 6 May 1993 to certain public servants.
s201(4) •
payments made in respect of an office or employment in which the holder’s service included foreign service where the period of foreign service was:
three-quarters of the whole period of service up to the date of termination, or
where the period of service exceeded ten years, the whole of the last ten years, or
where the period of service exceeded twenty years, one-half of that period including any ten of the last twenty years.
s201(1)
Foreign service is defined as a period of employment the emoluments in respect of which were not chargeable to Irish tax, or if chargeable to Irish tax, were chargeable on the remittance basis;
On foot of the changes introduced by Budget 2006 Financial Resolution No. 2 in relation to foreign employments, the Revenue Commissioners issued e-Brief No. 16/2006 concerning Foreign Service Relief in respect of termination payments. This provides that, as respects services provided with effect from 1 January 2006, the performance of duties of a foreign office or foreign employment in the State will not be considered by the Revenue Commissioners as foreign service. The performance of duties of a foreign office or foreign employment (other than a United Kingdom office or United Kingdom employment) outside the State by a person not domiciled in Ireland, or by a person, who is a citizen of Ireland, not ordinarily resident in Ireland, will be foreign service.
Tax Briefing (Issue 51) sets out Revenue’s view that no income tax charge will be imposed on the employee in respect of the payment of legal costs recovered by an employee from an employer as part of a court action to recover compensation for loss of office or employment where the payment is made by the former employer directly to the former employee’s solicitor, the payment is in full or partial discharge of the solicitor’s bill of costs incurred by the employee only in connection with the termination of his/her employment and the payment is under a specific term in the settlement agreement. This will apply to payments made either under a court order or where a settlement is reached outside of the court.
A similar provision is set out in Tax Briefing (Issue 60) in relation to legal fees recovered by an employee as part of an action taken for breaches of employment law by the employee or director against his or her employer.
s201(5)(a) •
payment of the basic exemption which amounts to €10,160 plus €765 for each complete year of service.
Reliefs
In addition to the basic exemption, there are two types of reliefs available to an individual who finds himself liable to tax on a termination payment under s123:
(1) Relief by reduction in the amount chargeable under s123;
(2) Relief by reduction of the tax payable.
(1) Relief by reduction in amount chargeable.
There are two elements of relief available under the heading, each of which is discussed below.
(a) Increased exemption
Sch3 Para 8
From January 2002, the basic exemption may be increased by a maximum of €10,000 if,
(i)
no claim for relief (other than the basic exemption) has been made in respect of a previous lump sum payment within the previous 10 years, and
(ii)
no tax free lump sum has been received or is receivable under an approved superannuation scheme relating to the office or employment. If a tax free lump sum of less than €10,000 has been received or is receivable from the scheme the increased exemption will be the basic exemption plus €10,000, less that amount, or, in the case of deferred benefits, the actuarial value of that amount.
Sch3 Para 6 (b) Standard Capital Superannuation Benefit (SCSB)
The basic or increased exemption may be increased further to an amount called the Standard Capital Superannuation Benefit (SCSB). It is important to note that the maximum reduction in the amount chargeable to tax is the SCSB or the basic/ increased exemption, whichever is higher.
The SCSB is calculated by the formula:
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A = the average for 12 months of the emoluments of the employment for the last 36 months of service, to the date of termination.
Emoluments for this purpose includes salary, benefit-in-kind, etc. before deduction of superannuation contributions.
B = whole number of complete years of service in the office or employment.
C =
any tax free lump sum received or receivable under any approved superannuation scheme.
The term “lump sum received or receivable” as used in the calculation of the increased exemption and SCSB does not include amounts received by an employee as refunds of personal contributions from a pension fund, which have borne tax at 20%.
Sch3 Para 1(1) Any lump sum arising from a right or option to commute a pension
in whole or in part in favour of a lump sum must be deducted in
arriving at the increased exemption or SCSB, irrespective of whether
the option is exercised or not. This condition may be waived subject
Sch3 Para1(2)(b) to the terms of the particular pension scheme if the employee irrevocably surrenders the right or option to commute all or part of the pension for a lump sum and has done so at the date of termination. In the case of deferred pension entitlements it is the actuarial value of any tax free lump sum which is deducted.
Revenue approval
s201(6) The legislation provides that relief for the Increased Exemption/SCSB is available by way of repayment of tax at the end of the tax year in which the termination of employment occurs. With regard to payments made on or after 25 March 2005, the time limit for making such a claim is 4 years after the end of the year of assessment in which that payment is treated as income. However, on receipt of an application, it was Revenue practice to grant permission for the Increased Exemption/SCSB to be deducted in calculating the PAYE/PRSI due on a termination payment. In November 1997 the Revenue advised that prior Revenue approval is no longer required for the tax-free payment of the SCSB amount but continues to be required for the Increased Exemption.
s201(5)(b) Aggregation rule
Sch3 Para 7 Termination payments made in respect of the same office or employment or in respect of different offices or employments held under the same employer or associated employers (e.g., in a group situation) must be aggregated for the purposes of calculating the basic exemption, the increased exemption and the SCSB.
Foreign service not sufficient to exempt
Sch3 Para 9 An individual who has had foreign service in the office or employment, but has not obtained full exemption under s201 from tax on the payment may have the payment (as reduced by the above reliefs) further reduced by the following amount
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P = Payment (as reduced by SCSB or basic/increased exemption)
FS = number of years of foreign service
TS = number of years total service.
Sch3 Para 10 (2) Relief by reduction in tax payable.
The taxable amount of the payment (i.e., payment less reliefs under (1)) is included in the individuals gross income for the year in which the payment is treated as received. Tax will thus be payable at the taxpayers marginal rate(s) on this amount.
Schedule 3 gives a measure of relief to the taxpayer by limiting the rate of tax payable on the taxable portion of the payment to the average rate of tax (i.e., tax payable/taxable income) borne by the individual over the previous three tax years. (Amended by s19 Finance Act 2005 for all payments after 1 January 2005, previously five tax years).
The income tax on the taxable payment (treating the taxable payment as the highest part of the individuals income for that year) is reduced by an amount calculated by the following formula:
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A = the tax which would be payable if the taxable lump sum was treated as income earned in the year of assessment, less the amount which would be payable if the lump sum had not been paid;
P = the taxable lump sum;
T = the aggregate of tax payable in respect of the total income of the individual for the three preceding years of assessment, (note that the tax payable on total income excludes tax on charges); and
I = the aggregate of the taxable income of the individual for the three preceding years of assessment. Note that it is the taxable income which is taken into account for the purposes of the formula and not total income.
Example
John Spring is made redundant on 31 October 2007 after 22 years service with Brook Sales Ltd (start date of 1 May 1985). He received the following as part of the redundancy “package”.
Statutory Redundancy
€27,624
Pay in lieu of notice
€1,000
Ex-gratia payment
€44,440
Company Car worth
€24,125
Mr Spring spent five years working in the Chicago head office of Brook Sales US Ltd from 1990 to 1995.
Mr Spring’s salary and benefit-in-kind amounted to €36,822 in the period 1 January 2007 to 31 October 2007. He obtained a position as senior sales executive with Office Equipment Ltd after his redundancy and he earned €7,850 in the period 1 November 2007 to 31 December 2007.
Mr Spring receives Government stock interest of €500 (gross) annually. His emoluments for the three years 2004 to 2006 were as follows:
€
2004
Salary
22,000
Benefit-in-kind
3,000
25,000
2005
Salary
25,000
Benefit-in-kind
3,000
28,000
2006
Salary
30,720
Benefit-in-kind
2,590
33,310
At the date of his termination the actuarial value of his tax-free lump sum entitlements under the pension scheme amounted to €5,860.
Mr Spring is married. His taxable income and tax chargeable on total income for the three years 2004 to 2006 are as follows:
Year
Taxable Income
€
Tax Payable
€
2004
25,500
630
2005
28,500
1,090
2006
33,810
1,912
Mr Spring’s tax liability for 2007 is arrived at as follows:
(1)
Calculate the taxable portion of the redundancy package after the appropriate reliefs.
(2)
Calculate the tax payable on his income assessable for 2007, including the taxable termination payment.
(3)
Calculate the “[broken link removed]top[broken link removed]-[broken link removed]slicing[broken link removed]” relief available to Mr Spring on the taxable termination payment.
(4)
Deduct the relief at (3) from the tax payable at (2), to give the final liability for 2007.
(1)
The statutory redundancy of €27,624 is exempt. The pay in lieu of notice of €1,000 is within s123 as Mr Spring was not entitled to pay in lieu of notice under the terms of his contract of service. The ex-gratia payment and the value of the car transferred to Mr Spring are both within s123. The “termination payment” is thus €69,565.
The reduction granted in arriving at the amount chargeable is the higher of:
(a) the basic exemption of €26,990 (€10,160 + €765 x 22 years)
or
(b)
The increased exemption of €31,130, i.e., (€26,990 + €10,000 less actuarial value of €5,860).
or
(c) The SCSB, which is calculated as follows:
(
A x B
)
–
C
15
A =
1/3 (36,822 + 33,310 + 28,000 + (25,000 x 2/12)) = 1/3 (102,299) = 34,100
B = 22
C = 5,860
SCSB =
34,100 x 22
–
5,860
=
44,153
15
€
Chargeable termination payment:
€69,565 – €44,153 =
25,412
Less relief for foreign service:
€25,412 x 5/22 =
5,775
Net chargeable termination payment
19,637
(2) Mr Spring’s 2007 income tax liability is calculated as follows:
(a)
Without termination payment:
€
Salary and BIK (Brook Sales Ltd)
36,822
Salary (Office Equipment Ltd)
7,850
Government stock interest
500
Gross Income
45,172
Taxable as follows:
€ 43,000
@ 20%
8,600
€ 2,172
@ 41%
891
€ 45,172
9,491
Less Credits
Personal
(3,520)
PAYE
(1,760)
Home Carer’s Allowance
(770)
(6,050)
3,441
(b)
With termination payment:
Tax liability as above
3,441
Add: Taxable termination payment 19,637 @ 41%
8,051
Total tax liability
11,492
(3) Calculation of Top-Slicing Relief:
[broken link removed]
A = 8,051
P = 19,637
T = (630+1,090+1,912) = 3,632
I = (25,500+28,500+33,810) = 87,810
8,051 –
[
19,637 x
3,632
]
= 7,239
87,810
(4)
Final tax liability for 2007
€
Total tax liability per (2)(b)
11,492
Less top-slicing relief per (3)
(7,239)
Final tax liability
4,253