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.
How settlement agreement payments are treated for tax purposes depends on the basis on which they are paid. Generally speaking, the first £30,000 compensation for the settlement is tax free, but this does not apply to all types of payment.
Payments made for the period up to the point termination of employment are subject to deductions of tax and national insurance in the normal way. This will include sums for accrued but untaken holiday pay, bonuses, commissions and so on. Any considerations paid for restrictive covenants and confidentiality will be fully taxable, as will payments made in lieu of holiday.
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.
Pay in lieu of notice (PILON) is sometimes taxable, but this will depend on the terms of the contract of employment (or whether it is custom or practice for an employer to make a PILON). Where they are not allowed, payments are paid gross and will count towards the £30,000 exemption.
It is important to get the tax treatment right because HMRC may well claim tax later where payments have wrongly been made gross. Normally on a settlement 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 settlement 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.
A payment made on account of a disability or injury will not be taxable. Payments for Injury to Feelings arising from unlawful discrimination occurring before the termination of employment will also not be taxable. Outplacement counselling or training costs are not taxable. Any contributions to a registered pension scheme are treated separately and not subject to tax. Statutory redundancy payments are paid tax free.
Settlement agreements and tax can be one of the trickiest aspects to consider. Make sure you get professional advice. Ironmonger Curtis has an excellent reputation for getting results, and for jargon-free, common-sense advice. You can rest assured you are in good hands with us. Speak to us today for settlement agreement advice. See our settlement agreements page and our settlement agreements terms guide for more information.
Settlement Agreement & Tax Legal Advice Sheffield
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