Tax treatment in settlement agreements
Employment Law- tax treatment in settlement agreements
Please note that the below information is general in nature and not intended to amount to specific advice on your personal circumstances. Landau Law does not provide tax advice and you are always recommended to go to an expert tax advisor if you have specific requirements.
Will you be taxed on the ex-gratia payments in your Settlement Agreement?
Ex- gratia payments are made by your employer as compensation when you leave employment, which is over and above what you are entitled to be paid in your contract of employment (such as notice, bonuses and holidays). As a general rule, the first £30,000 of such payments can be paid free of tax and NICs.
If a settlement agreement offers compensation which exceeds £30,000, the excess will be subject to tax at your appropriate marginal rate. Compensation payments are not earnings for NIC purposes and are exempt from NIC completely even if they exceed £30,000.
If you have been made redundant, will redundancy payments be payable tax free?
Both contractual redundancy payments and statutory redundancy payments fall within the £30,000 exemption. Once you have reached the £30,000 ceiling for any combination of these payments and/or an ex-gratia payment, you will have to pay tax.
What about pension contributions?
HMRC treats payments made direct into pension schemes totally separately from the £30,000 exemption and they are not subject to tax.
Will your pay in lieu of notice be taxable?
Yes, all notice is now taxable, regardless of whether you have a pay in lieu of notice clause (“PILON”) in your contract of employment.
Will your salary, bonus and benefits be subject to tax as normal?
Your salary, benefits and bonus entitlement payable up to and including the termination date will have tax and national insurance deducted in the usual way. You cannot shift a bonus payment due on termination into the tax free exemption by referring to it as part of your compensation, if the intention is to avoid paying tax on sums properly due.
What is Post Employment Notice Pay (“PENP”)?
PENP is the basic pay equivalent for any un-worked notice period calculated using a specified formula. Where an employee is not employed for the full notice period, any “relevant termination award” will be taxed as general earnings (and therefore subject to income tax and Class 1 employer’s and employee’s NI) in so far as it is equal to (or less than) the PENP.
There is no need to calculate PENP where you work your full notice period, or where you only receive PILON (i.e. no ex-gratia payment) as there would be no ‘relevant termination award’.
If you have accrued but untaken holiday, will the pay in lieu be taxable?
Payments in lieu of accrued holiday will be taxed in the same way as salary. They cannot be part of the tax free exemption.
Are contributions to outplacement services taxable?
Contributions to outplacement services not taxable, and also do not count towards the £30,000 exemption. These costs are sometimes paid directly to the outplacement provider instead of to you first.
Should the consideration payment for restrictive covenants be subject to deductions?
Sometimes, the settlement agreement will require you to comply with new restrictive covenants, or confirm the existing covenants which appear in your contract of employment. In order to make these terms binding and enforceable, an employer needs to provide a nominal payment for this, which is known as “consideration”. A typical payment is a nominal sum of around £100 – £200 and it is always subject to tax and NIC deductions.
Are there any other payments which are also subject to tax?
Some settlement agreements may also contain a small consideration sum to make a confidentiality clause binding, and this too will be taxable.
Taxation of share options and share awards
You may be entitled to exercise share options and receive share awards either before or at some point after termination. The tax and NICs liabilities will depend on many factors including whether the scheme is tax-advantaged, the length of ownership and the reason for cessation of employment. A cash cancellation or compensation payment will be fully taxable.
Can payments for personal injury and injury to feelings following discrimination be paid tax free?
If the payment relates to injury to feelings for discrimination and the payment is not related to the termination of employment (i.e. in relation to events leading up to the termination), it can generally be paid tax free. However, payments for injury to feelings under a settlement agreement are taxable, as the discrimination and subsequent compensation are being paid in connection with the termination of employment.
No tax is payable during employment or on a termination payment (or part of a termination payment) where the payment is related solely to the personal injury of an employee. The definition of “injury” specifically includes psychiatric injury, but specifically excludes injury to feelings. This means that payments for personal injury (including psychiatric injury) which form part of a settlement are not taxable.
What if the termination payments stagger a tax year?
Most termination payments are made in one lump sum, but there are instances where the payments are staggered or delayed. It may be better from a tax perspective for some of the payments to be made in a new tax year, and in some cases, it is worth considering a specific request to your employer to delay payment, especially where large sums are involved.
Please contact Philip Landau or any member of the employment team at Landau Law on 020 7100 5256 for further advice, or complete the contact form below, or email firstname.lastname@example.org Please click here for details of our being able to provide free legal advice.