Settlement Agreements

August 27, 2015


Do I have to pay tax when I am being made redundant/my employment is being ended?

It is very common for contracts of employment to end by agreement, leading to a termination payment incorporated in a Settlement Agreement. The termination payment might be made up of several different elements including payment in lieu of notice (PILON), compensation for loss of office, statutory redundancy and in certain cases damages. The termination payment will include a payment in relation to any holiday that the employee has accrued and has not taken. It is often thought that all payments made on termination of employment up to £30,000 are free of tax and National Insurance payments. However, that is not the case.

The elements of the termination payment to which the employee is contractually entitled such as PILON and accrued holiday should be subject to tax and National Insurance deductions whereas other elements of the payment which are not part of the contractual entitlement do not suffer deduction.HM Revenue and Customs have now started to investigate this area,not least because there was a growing suspicion that the current system created unfairness. Those who were better paid and possibly better advised were often able to structure the termination payment and Settlement Agreement in a way that allowed them to minimise taxation. As a result of this the Office of Tax Simplification produced a final report on a review of employee benefits and expenses in July 2014 and HM Revenue and Customs published a consultation document in July 2015 seeking a response from stakeholders before a final decision is made. It is too early to say what the outcome might be but the consultation document suggests that there is a leaning towards tax exemptions and termination payments to be:-

a.    linked to statutory redundancy payments or;

b.    increased proportionately by the number of years’ service completed by the employee concerned.

The situation is complicated enough at the moment and may become more so. Any employee faced with a Settlement Agreement containing a termination payment should take proper advice on the way in which that payment is to be taxed.

Please contact:-

Quintin Barry & Simon Dodds on 01323 720142