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Compromise Agreement Tax Implications                             Call 0800 292 2411

Are Compromise Agreements and Settlement Agreements taxable?

How Compromise Agreement and Settlement Agreement payments are treated for tax purposes will depend on the basis upon which they are paid.

Salary and benefits to date of termination
All payments made for the period up to the point that the contract of employment ends are subject to deductions of tax and national insurance in the normal way.

Payment in lieu of holiday
Very often an employee will have holiday owing to them when the employment ends. Payments made in lieu of such holiday are taxable.

Pay in lieu of notice (PILON)
Whether pay in lieu of notice is taxable depends on whether such payments are allowed for in an employee’s contract of employment. This information could also be in an employee handbook rather than the written contract. Where they are allowed, they will be taxable like other contractual payments. Where they are not, they can be paid gross and will count towards the £30,000 exemption.

Where it is the custom and practice of an employer to make a payment in lieu of notice (PILON) even if it is not part of the contract, HM Revenue & Customs may consider that tax should be deducted. The question is whether payments are made automatically or considered on each occasion.

Compensatory and ex-gratia payments (non-contractual) payments
Compensatory, ex gratia (non-contractual) payments made for loss of office or employment are exempt from tax on the first £30,000.

Redundancy payments
Both statutory and contractual redundancy payments fall within the £30,000 exemption.

Payments for restrictive covenants and confidentiality obligations
An employer may wish to restrict an employee from acting in competition or approaching customers or employees once they have left the business. If the contract contains enforceable restrictive covenants, the employer will be able to rely on these if it has not breached the contract when terminating the employment. However, sometimes the contract does not contain such provisions, or the contract contains restrictions that are too wide to be enforceable. If this is the case, the employer can seek new restrictions.

To make these binding in law there must be a ‘consideration’ paid, usually of a small sum, frequently £100. This payment is fully taxable and liable to national insurance contributions.

Some Compromise Agreements and Settlement Agreements may also include a consideration associated with a confidentiality clause. These are also subject to deductions.

Outplacement costs
Contributions to the cost of outplacement counselling or similar training are not taxable and are usually paid directly by the employer and therefore do not count towards the £30,000 exemption.

Payments for Injury to Feelings
Payments made to compensate for injury to feelings arising from unlawful discrimination that occurred before the termination will not be taxable. Where the injury to feelings was caused by the termination they will be.

Payment on account of a Disability or Injury
A payment can be made free of tax where it is on account of a disability or injury (and also death). The payment must relate to the fact of the injury or disability and not to any consequential affect on earnings.

Contributions to a registered pension scheme
Payments made direct into a pension scheme are treated separately and are not subject to tax. There are annual and lifetime allowances for contributions to registered pension schemes and contributions in excess of these allowances do incur tax charges.

Legal costs
Usually the employer pays the employee’s legal costs. This does not count towards the £30,000 exemption as long as it is solely in connection with termination of employment, is paid directly to the employee’s solicitor and there is a specific Compromise Agreement or Settlement Agreement clause to that effect.

Sums exceeding the £30,000 exemption
If the Compromise Agreement or Settlement Agreement includes compensation that exceeds the £30,000 exemption, prior to 6 April 2011 tax was deducted at basic rate on the additional amount. If the employee was liable for higher rates of tax they were responsible for accounting to HM Revenue & Customs for this. The employer now has to deduct tax at the OT tax code rate which may mean making deductions at different rates from 20 to 50 per cent depending on the size of the excess. The OT Code does not include any personal allowances and divides the different tax bands into twelfths.

 

National Coverage throughout the UK for Settlement Agreement and Compromise Agreement advice for Employees 

iSettlementAgreements advise employees throughout the UK on matters related to Settlement Agreements and Compromise Agreements.  Wherever you are in England, Scotland and Wales, iSettlementAgreements' solicitors can provide you with professional advice on your Settlement Agreement or Compromise Agreement.

Telephone 0800 292 2411 or 07906 200 469 for advice on your Settlement Agreement or Compromise Agreement.