EIM13695 - Foreign service: application of double taxation agreements to termination payments

Where a termination payment is made to an employee who has been working outside the UK, it may be that the UK does not have sole taxing rights over that payment or a part of that payment. In such cases the provisions of any double taxation agreement (DTA) between the UK and the other country need to be considered.

DTAs operate to consider where taxing rights lay between 2 countries in respect of different elements of termination payments. Most DTAs are silent on the treatment of termination payments but the OECD provides commentaries on how DTAs are to be applied in certain circumstances. Details of how termination payments are to be treated are included in the OECD commentary on Article 15, which is the article which deals with double taxation arising from employments. Most countries who sign up to DTAs (including the UK) have agreed to abide by these provisions.

In arriving at the correct treatment for each element of a termination payment, it will be necessary to consider the OECD commentary. Different types of payment relating to the termination may be treated differently depending on the circumstances. For example the commentary provides that payments for notice not worked should be taxed in the country in which the employee usually worked. Taxing rights for payments for unused holiday pay from past years service should however be split according to the employee’s residence in the last 12 months of his or her employment. It will therefore be necessary to consider how the commentary applies to each individual element of a termination payment before determining whether the element should be taxed in the UK, the other country or both.