Settlement Agreement Tax

Settlement Agreement Taxation of awards

If there are any complex tax issues in relation to a settlement, it is essential to obtain specialist tax advice. The basic tax position (at the time of writing) is as follows:

  • Contractual payments (e.g. a payment for unused holiday or a contractual PILON), it will be subject to income tax.

  • Payments for entering into a restrictive covenant (whether enforceable or not) are subject to income tax.

  • Non-contractual payments in lieu of notice (where termination occurs and payment is made on or after 6 April 2018) will be subject to income tax. If a payment is made to an employee on the termination of their employment and the employee has not worked their full notice period, the amount reflecting the basic pay the employee would have earned if they had worked their notice is subject to income tax.

  • Genuine compensation for loss of office is tax-free up to £30,000, for example ex gratia payments; damages for wrongful dismissal; compensation for unfair dismissal or other breach of statutory rights.

  • Statutory redundancy pay is tax-free up to £30,000. A non-statutory redundancy payment may be taxable as earnings, if it includes a non-contractual payment in lieu of notice. The amount paid on termination reflecting the basic pay the employee would have earned if they had worked their notice is subject to income tax.  

  • The tax treatment relating to compensation for discrimination is not entirely clear but the current position can be summarised as follows:

    • If the discrimination giving rise to the payment is not related to the termination of employment and the payment relates to injury to feelings, it can be paid tax-free.

    • If the discrimination giving rise to the payment is not related to the termination of employment and the payment compensates for financial loss, the payment might be taxed as earnings if the compensation is viewed as a substitute for the pay and benefits that the individual should have received.

    • If the discrimination giving rise to the payment is related to the termination of employment, any compensation for loss of employment will be taxable.