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Tax on Termination Payments

We are employment solicitors advising on Settlement Agreements in Central London. Does tax need to be paid on the sums received under Settlement Agreements?


It used to be the case that employers only had to deduct basic rate tax on Settlement Agreement payments exceeding £30,000.  This makes it clear that the 0T tax code is to be applied on a “non-cumulative” basis. For an employee paid on a monthly basis, this means that only 1/12th of their basic rate band (and, if relevant, 1/12th of their higher rate (40%) band) is available in the month of payment. This will mean that if the termination payment is more than the appropriate proportion of the 20% band, the excess will be taxed under PAYE at 40%, and if the payment is also more than the available 40% band, the excess will be taxed under PAYE at 50%.


The practical impact of this change is that, as a general rule, employers should make termination payments before issuing the P45 if possible. This will ensure (so far as possible) that the correct amount of tax is deducted and avoid, for example, a basic rate taxpayer having to reclaim overpaid tax through self-assessment if they don’t get another job.


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