0207 118 0950
Request a call

Can payments in Settlement Agreements be paid free of tax?

Some payments can be paid free of tax under Settlement Agreements. We will advise you on this and if appropriate will negotiate to ensure that the payments are made in a tax efficient manner.

It’s very important to get the taxable position on payments made under settlement agreements right, whether a redundancy situation arises. Most people have heard that the first £30,000 can be paid free of tax, but that is not always the case as you can see below.


Salary & benefits to termination date:

S62 Income Tax (Earnings and Pensions) Act 2003 (‘ITEPA’) defines taxable earnings as: (a) any salary, wages or fee; (b) any gratuity / profit / incidental benefit of any kind obtained by the employee for money or money’s worth; or (c) anything else that constitutes an emolument of the employment. This will include payments prescribed by employment contract & payments by third parties including tips.

Salary & benefits to the termination (including ‘garden leave’) will therefore be taxable as normal (s405 ITEPA).

Payment in lieu of holiday accrued but untaken to the termination date:

Such payments accrue as a contractual / statutory obligation, are taxable earnings and are therefore taxable in the normal way under s62.

Ex Gratia & Compensatory Payments:

Under s401 & 403 ITEPA, ex gratia (non-contractual) payments as compensation for loss of office or employment will be only taxable subject to the exemption on the first £30,000. In other words the first £30,000 can effectively be paid without deductions.

However if the employer habitually makes such a payment or if the employee reasonably expects to receive it, then this may amount to employment earnings under s62. In other words sums habitually paid in accordance with a fixed formula may well attract tax unless paid on redundancy (see below).

Payment in lieu of notice:

At the beginning of April 2018, the law changed so that all payments in lieu of notice, whether contractual or statutory, must be subject to tax. The liability for tax cannot be avoided by calling something else (for example lumping the payment into an ex gratia payment).




Statutory Redundancy Payment:

Statutory redundancy payments are included in the calculation of the total £30,000 exemption.

Contractual Redundancy Payments:

Payments under contractual redundancy schemes will benefit from the £30,000 exemption as long as it’s a genuine redundancy situation.

Payments in consideration for post termination restrictions:

S225 ITEPA treats any payment relating to post termination restrictions on employment as earnings from the employment and chargeable to tax under S.62. This does not however appear to cover payments for confidentiality clauses which continue after termination as they do not restrict future employment.

In other words a specific payment in a compromise agreement to abide by a post termination restriction on future employment or business activities will be taxable in the normal way under s62.

Non Monetary Payments:

Non-monetary benefits, (unless provided pursuant to the employment contract) will normally included in the total £30,000 exemption. In other words their cash equivalent needs to be ascertained (s415) when calculating the total value of payments under s401 & s403. However certain non-cash benefits may be dealt with separately from the £30,000 exemption under s401 & 403 when paid on the termination of employment, including benefits provided in connection with a taxable car or van, mobile telephone & certain provision of computer equipment (see s402(2) ITEPA).

Outplacement Counselling:

Many employers contribute to the cost of outplacement counselling in the compromise agreement. These contributions won’t count towards the £30,000 exemption and can be disregarded when calculating the total exemption amount (s310 & 311 ITEPA).

Contributions to Pension Scheme:

An employer’s contribution to an approved retirement benefit scheme in a compromise agreement is dealt with separately from the £30,000 exemption (s408 ITEPA). (See also sections 407 and 637(1)(b) ICTA for lump sums under a tax-exempt pension scheme.)

Legal costs:

If the employer pays the employee’s legal costs solely in connection with termination of employment, it will not count to the s401 allowance of £30,000 as long as it’s paid directly to the employee’s solicitor & there’s a specific term to that effect in the compromise agreement (Extra-statutory concession A81).

Contact us:

Our specialist employment solicitors based in Central London (Holborn WC1V) can advise on all aspects of settlement agreements and compromise agreements. Contact us today to discuss your particular situation.


Common Questions regarding Settlement Agreements

Copyright 2022 - Reculver Solicitors - Reculver Solicitors Ltd (Company No. 6910066) 27 Old Gloucester Street, London WC1N 3AX .