Will you be taxed on the ex gratia payments in your Settlement Agreement?
Ex gratia payments are the non- contractual payments paid by your employer as compensation for loss of office. As a rule, the first £30,000 of the compensation will be tax free. If a Settlement Agreement offers compensation which exceeds £30,000, the sum over and above £30,000 will be taxable. This sum alone will be taxed according to your usual income tax band (i.e. the basic rate of 20%, the higher rate of £40% or the additional rate of £50%).
Why does this tax exemption exist?
The first £30,000 is tax free to incentivise parties to settle their disputes without the need for litigation and reduce the cost to the taxpayer incurred by Employment Tribunals.
If you have been made redundant, will redundancy payments be payable tax free?
Both contractual redundancy payment and statutory redundancy payment fall within the £30,000 exemption. Once you have reached the £30,000 ceiling for any combination of these payments 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. If therefore, during negotiations, you are looking to receive over £30,000, you may wish to consider requesting that the amount over and above £30,000 is paid into a pension scheme.
Will your pay in lieu of notice be taxable?
This will depend upon your employment contract. If you have a pay in lieu of notice (“PILON”) clause in your employment contract, your employer is required to make tax and National Insurance deductions. If, however, your contract does not have a PILON clause, and your employer opts to pay you in lieu, this payment can come within the first £30,000 available tax free exemption. Please be aware, however, if you do not have a PILON clause, there is no obligation by your employer to pay you in lieu of notice.
Where there is a custom and practice by your employer to make a payment in lieu of notice, despite the absence of a PILON clause, HMRC may determine that tax should be deducted, because of their custom and practice.
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.
If you have accrued but untaken holiday, will the pay in lieu be taxable?
Payments in lieu of holiday are taxable in the same way as salary.
If you are offered paid outplacement services as part of the agreement are these taxable?
Contributions to outplacement counselling costs or similar training courses are not taxable and do not count towards the £30,000 exemption. These costs are often paid directly to the outplacement provider by your employer in any event.
Are there any other payments made within the agreement which might be taxable?
Sometimes, a Settlement Agreement requires an employee to comply with new restrictive covenants. In order to make these terms binding and enforceable, the Employer provides consideration. This consideration is often a nominal sum of around £100 – £200 and is fully taxable. Some Settlement Agreements may also contain a small consideration sum to make a confidentiality clause binding, and this too will be taxable.