Is a settlement agreement payment tax free?

Employment Law Solicitor

Is it true that my settlement payment can be made tax-free?

Jon Curtis, Partner at Ironmonger Curtis Solicitors answers…

It is likely that some of the payments and / or benefits under the settlement agreement will be taxable and others will not.

Generally, any payments which an employer is under a contractual obligation to make must be subject to deductions for tax and national insurance before they are paid to you. This may include, for example, holiday pay, contractual bonus payments and other contractual payments or benefits.

Notice pay will be taxable if you work your notice period. However, if you are paid in lieu of notice but the employer does not have the contractual right to do this (i.e. if there is no payment in lieu of notice (PILON) clause in your employment contract), there is a chance that it can be paid to you gross – i.e. without deductions for tax and national insurance.

The ex-gratia element of the settlement payment should not be a contractual payment, so can be paid free of tax, as long as it is below £30,000. Any ex-gratia payment over £30,000 will be subject to deductions in the usual way. However, sometimes employers will ‘lump together’ sums in the settlement payment which should rightly be subject to deductions. Your solicitor should be able to help you identify whether there is any tax risk on a payment like this.

It is now common for settlement agreements to include an indemnity clause in favour of the employer. This basically means that if HMRC considers that any aspect of a settlement payment not subjected to deductions should have been and issues a demand for further tax and national insurance contributions to the employer, the employee must reimburse the employer for this. This is to give the employer certainty on the amount they are paying out. Most employers will now insist on you agreeing to an indemnity clause. It is therefore important for you to properly consider and be comfortable with the extent of any risk you are taking on before signing the settlement agreement.

Taxation of settlement payments is complex, and in some circumstances employees may need to seek specific tax advice from a tax specialist.   

Answer by Jon Curtis (Solicitor) on 7 October 2013

IMPORTANT: The contents of this page are for guidance only and do not constitute legal advice. You should consult a solicitor without delay if you require legal advice on a particular employment matter.