An individual who received a £30,000 tax-free redundancy payout after 15 years with a company is being advised to exercise caution when considering a consulting role with their former employer. Experts warn that such arrangements can put the tax-free status of the redundancy payment at risk if the redundancy is not deemed genuine by tax authorities.
The primary concern is whether the redundancy was legitimate. The tax exemption for redundancy pay hinges on the role genuinely ceasing to exist. If an individual returns to perform similar work, even under a different title and through their own limited company, tax authorities like HMRC may argue that the redundancy was not real. This could lead to the payout being reclassified, potentially incurring tax liabilities.
Kate Underwood, founder of Kate Underwood HR and Training, emphasized that tax authorities focus on the substance of the work rather than job titles. "If you end up back in the same building doing recognisably the same work with a different label on it, they can argue the redundancy was never real and the payment was something else dressed up," she stated. While working on aspects of the business previously dealt with is not automatically disqualifying, the distinction between the old role and the new engagement must be clear to an objective observer.
The timing of the re-engagement also plays a crucial role. While there is no fixed period, a return to the former employer too soon after redundancy can be viewed unfavorably. In this case, the individual was made redundant at the start of June and is considering the consulting role in mid-August, providing some temporal distance that helps. The four-week re-engagement rule under the Employment Rights Act has passed, mitigating one specific regulatory concern.
Settlement Agreements and IR35
Beyond the genuineness of the redundancy, individuals must review their settlement agreements. These documents may contain clauses such as non-compete agreements, non-solicitation of clients or staff, confidentiality, or conditions that could trigger a clawback or repayment of the redundancy pay. Some agreements also include warranties that the employee had not secured other employment, particularly with competitors, before signing.
Furthermore, the arrangement falls under scrutiny related to IR35 regulations, which govern employment status. Consulting for a former employer, even on a part-time basis through a limited company, raises red flags for tax authorities. For medium and large businesses, the determination of employment status rests with the employer, and many may classify returning former staff as 'inside IR35' by default. Key factors in determining employment status include control over the work, the ability to substitute one's services, and mutuality of obligation.
To mitigate risks, practical aspects of the consulting arrangement need careful management. This includes having a genuinely different scope of work with defined deliverables, a formal contract for services, and ensuring invoices are issued from the limited company. Ideally, the consultant should supply their own equipment, determine their working hours, and negotiate a right of substitution. Crucially, the individual should avoid receiving employee benefits, using old company email addresses, or appearing on organizational charts as if they had never left.
Documenting the arrangement clearly at the time is essential. The prospect of working two to three days a week for the former employer, in addition to working a couple of days for a rival company, presents a full working week. This level of engagement could be interpreted by tax authorities as holding two jobs rather than operating an independent consultancy.
Experts also note a wider implication for employers. Rehiring someone on a day rate shortly after making their role redundant can undermine the perceived legitimacy of the redundancy process for current employees, potentially impacting morale and raising concerns about sham redundancies. Such practices can initiate claims from the tax authorities.