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Settlement agreements and tax

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Settlement agreements and tax

Settlement agreements (or compromise agreements as they used to be called), usually involve a payment from the employer to the employee. Such payments can attract income tax or national insurance contributions – but they can also sometimes rightly be paid tax free.

Clearly, any payments up to and including the termination date are likely to be taxed. This will include sums for accrued but untaken holiday pay, bonuses, commissions and so on.

However, a payment made in relation to the time after termination may be subject to tax under sections 401 to 416 of the Income Tax (earnings and pensions) Act 2003 (known as ITEPA) – which basically allows a tax free payment of up to £30,000.00 in the relevant circumstances.

Generally speaking, “earnings” are always taxable, and it is only “ex gratia” (without obligation) payments which can be made tax free.

It is important to get the tax treatment right because the Inland Revenue may well claim tax later where payments have wrongly been made gross. Normally ion a compromise agreement there will be a “tax indemnity” which means that if an employer is later asked to pay the tax by the employee, the employer can then pursue the employee for that tax: plus interest, penalties and the cost of “grossing up”.

A number of issues can make the taxation of compromise agreements complex, for instance shares and share options and payments in lieu of notice clauses. In such cases it may be necessary to get specialist tax advice.

Statutory redundancy payments are paid tax free.

Settlement agreements and tax can be one of the most tricky aspects to consider. Make sure you get professional advice!

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