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Legal costs on redundancy: get it right
Assume your employment is terminated. Assume you end up in dispute with your former employer. Assume you come to an agreement under which you are reimbursed your legal costs. Then no-one could possibly expect you to pay tax on that reimbursement could they?
Er... possibly.
The starting point is that the recovery is taxable as part of the termination package, albeit potentially subject to the £30,000 exemption for certain termination payments. Fair enough, provided you get relief for the corresponding expenditure. Alas the fly in the fuel supply (as it were) is that the legal fees don't meet the "wholly, exclusively and necessarily" test for deductions from employment earnings.
All is not lost though – some tax relief may be available under what used to be an extra-statutory concession and is now legislated at section 413A ITEPA 2003. The good news is that where the former employer pays legal costs in accordance with a Court Order or a Tribunal decision, the costs are always tax-free. The bad news is that if the dispute is settled "out of court" the costs are tax-free only if the payment is made:
- direct to the employee's solicitor rather than to the employee himself or herself,
- to discharge the bill for solicitor's costs that the employee has incurred only in connection with the termination of the employment, and
- under a specific term in the compromise agreement that settles the dispute.
Bizarre? There's more: this tax-free treatment applies only to amounts payable to a lawyer, not to any other professional, however closely connected with the case: such as, for example, an accountant or tax adviser. But it does apply to payment of a lawyer's disbursements (so get your lawyer to instruct any other advisers!). And if you aren't able to recover legal costs and you have to meet them from the global settlement, don't imagine you will get tax relief for the costs you bear: you won't.
Morals:
- On a case of this kind, instruct all advisers via your lawyer.
- Ensure that recovery of costs is pursuant to a specific term in the compromise agreement.
- Don't pay your lawyer and seek reimbursement: have the other side pay him or her direct.
And finally
- Don't even try to understand the logic of tax.
