Settlement Agreements and Tax Treatment

There is sometimes confusion about whether a payments made to an employee on termination of their employment are properly taxable or not. Sometimes the parties actively seek to agree terms in a settlement agreement with a view to avoiding liability for tax.

However, care must be taken that the wording of any settlement agreement accurately reflects the reality of the situation so as to avoid complications with the Inland Revenue; at the end of the day, the employee is responsible for paying the proper amount of tax.

The following payments will usually be treated in the way set out below:

  • Payments of salary, including accrued holiday pay, are taxable in the normal way. This would include payments in respect of a period of notice, or where there is a Payment In Lieu of Notice (PILON) clause that contractually allows the employer to choose to not require the employee to work the remaining notice period.
  • A payment made to an employee in respect of notice pay where there is no PILON clause are usually exempt up to £30,000. This is because such a payment is technically a breach of contract, unless it is the common practice of a company.
  • Similarly, payments for loss of office, or injury to feelings in discrimination cases fall within the £30,000 exemption.
  • Bonus payments will be subject to tax in the normal way.
  • Payments made direct to your pension scheme are exempt from the £30,000 limit and are not subject to tax.
  • Redundancy payments (whether contractual or statutory) fall within the £30,000 exemption.
  • Payments are taxable where they are made as consideration for the employee entering into a restrictive covenant or additional terms as to confidentiality and such like.
  • Contributions towards retraining or outplacement services are not taxable and do not contribute to the £30,000 exemption.
  • In certain cases where large sums of money are being paid, it may be possible to agree to defer or stagger certain payments so that there is more favourable tax treatment over successive tax years.

For assistance with your settlement agreement, please ask to speak to Kevin Grant on 01904 655 555.