Settlement (compromise) payments and tax

The tax provisions in settlement agreements often appear confusing however, ignorance or misunderstanding of the tax treatment of your settlement package could be costly. It is therefore imperative that that tax provisions are drafted correctly to reflect the intentions of both parties and that you fully understand them.

Under the statutory tax provisions, the first £30,000 in connection with 'the loss of employment or office' is free from income tax but only if the payment would not be otherwise taxable and there are complicated rules about this. Anything payment over £30000 would be taxable, for example, compensation in relation to unfair dismissal and/or discrimination claims or compensation for agreeing to new restrictive covenants.

Employers will be liable to pay National Insurance Contributions (NIC’s) on payments which constitute earnings from employment and this can add significantly to the costs of settlement. It is important that the termination payment is taxed correctly, as (HMRC) can recover unpaid tax and NICs, penalties and interest from the employer.

Your employer will be aware of this and may insert an indemnity clause into the agreement. This means that if HMRC investigate your settlement package and are of the opinion that income tax and NIC’s should have been payable then you must indemnify your former employer for these contributions. It is therefore essential that you are satisfied that the tax provisions are drafted correctly and treat elements of your settlement package in accordance with the tax rules.

The tax provisions of your settlement agreement must therefore be scrutinised and fully understood by you. Our expert team can advise you on the terms and their effect and therefore if you are in any doubt then please contact us.

If your settlement agreement is silent on tax issues you should seek specific advice.

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