Home > Blogs > Am I Liable to Pay Settlement Agreement Tax?

Am I Liable to Pay Settlement Agreement Tax?

Posted by Davenport Solicitors Team on November 26, 2021 in Settlement Agreements

Whether or not payments made under a settlement agreement are taxable depends on to what the particular payment relates. A termination package in a settlement agreement will typically comprise various contractual and non-contractual elements, some of which may be liable to income tax and some of which may be tax-exempt. 

The tax position of termination packages is complex. The nature of the event bringing about the termination of employment is another factor that can further complicate the tax position. The employer should start by precisely identifying each payment within the termination package and then considering the tax provisions applicable to it. In this post, we answer the question: am I liable to pay settlement agreement tax?

Do I Pay Tax on a Settlement Agreement?

As a general rule, payments chargeable to income tax under s.62 of the Income Tax (Earnings and Pensions) Act 2003 include: outstanding salary payments and holiday pay; other earnings derived from employment such as outstanding bonus or commission payments; non-cash benefits in kind, such as the retention of a company car; other payments made under the employee’s contract of employment; a payment to induce the employee to enter into or abide by post-termination restrictive covenants; and payments given in connection with termination of employment that cannot be charged to income tax in any other way, to the extent that, as a whole, they exceed £30,000.

There is a £30,000 exemption in s.401 in respect of those elements of the termination package not otherwise chargeable to income tax that are received in consequence of the termination of employment. The first £30,000 of the following payments benefits from the tax exemption referred to above: statutory, contractual and ex gratia redundancy payments made on account of genuine redundancy; and non-contractual ex gratia payments made as compensation for loss of employment, e.g. anticipated damages on account of unfair dismissal. 

How Much Settlement Agreement Tax Will I pay?

As previously stated, the first £30,000 of a settlement payment is tax-free. Sometimes this is called a compensation payment or an ex-gratia payment. Ex gratia means, “as a gift”. In the case of tax law and employment, it means the employer was not obliged to pay it under the terms of the contract of employment.

If the settlement exceeds the £30,000 exemption, you will in most cases be liable to pay tax.

Your employer will be responsible for deducting tax at the oT tax code, calculated on the basis that personal allowances are not included and the tax bands are to be divided into twelfths aligned to tax months. For the employer, this could mean making deductions at rates varying from 20% to 45%, depending on how much over the £30,000 threshold the payment is.

If you have any outstanding salary payments up to the date your settlement agreement states your contract ends, these will be taxed as normal, with the usual deductions for tax and national insurance.

Similarly, if you have any holiday payments owed up to the date your employment ends, these will also be subject to the usual tax deductions.

Employees are also taxed on any payment in lieu of notice (PILON). Since 2018, there is no longer a distinction between the tax owed on notice payments made to employees with a PILON clause in their employment contract. When this new rule was introduced, the government created a standard statutory formula that employers should apply to ensure any pay in lieu of notice is taxed correctly. The settlement agreement should state the amount of payment in lieu of notice you will receive.

Who Pays Your Legal Costs?

For the settlement agreement to be legally binding, the employee must seek independent, professional advice before they sign to confirm they understand the terms they are agreeing to, such as waiving their employment law rights.

Usually, employers will pay the legal costs for this advice, and this would be included as a term in the agreement.  The employee should discuss this with your employer before engaging an adviser to confirm if and how much they will cover for your legal expenses in relation to the settlement agreement.

Settlement Agreement Advice from our Solicitors in London

If you would like Davenport Solicitors to support you with further advice on Settlement Agreements or to speak to our settlement agreement solicitors in london, we welcome you to visit our contact us page, or contact us directly by emailing contact@davenportsolicitors.com or giving our experts a call on 02079 036888.

The material contained on this website contains general information only and does not constitute legal or other professional advice and should not be relied upon as such. While every care has been taken in the preparation of the information on this site, readers are advised to seek specific legal advice in relation to any decision or course of action.

Request free call back

Call us today for a free, no obligation chat.

You’re welcome to call us on +44 020 7903 6888 or email us . We aim to reply within 24 hours.

I have read the privacy policy and agree to you processing my personal information

[honeypot honeypot-691]

Associations and

Show Buttons
Hide Buttons