many thanks for your had work and professionalism
No employee wants to pay more tax than they have to. This is especially the case with payments paid under the terms of a settlement agreement where tax deductions can substantially reduce the net amount of compensation you end up with.
How much tax may I need to pay?
The amount of tax that you need to pay on any payment under a settlement agreement depends on the amount and what it is for. Some payments can be made tax-free whilst others must be taxed.
What payments must be taxed?
As a general rule, any sum that you are entitled to under your contract of employment that relates to your past or future employment is generally taxable in full. Therefore, payments made in the circumstances below will normally be taxable and suffer deductions of income tax and national insurance contributions:
- your salary or wages and accrued holiday entitlement up to and including the termination date of your employment. This is the case even if you are on garden leave
- any payment in lieu of notice made under a contractual pay in lieu of notice clause
- a payment in lieu of notice paid under an established “custom and practice” arrangement
- a payment of contractual bonus or commission that has or will become due as payable to you.
New restrictive covenants and confidentiality clauses
Additionally, if you are required to enter into new restrictive covenants or extended obligations relating to your employer’s confidential information great care must be taken to ensure you pay tax on only a small proportion of the compensation payment. This is because both requirements require the employer to make income tax deductions on all or some of the compensation payment in such cases.
At Quantrills our employment law solicitors will make sure this issue is correctly dealt with so that any tax deductions are kept to the absolute minimum.
What payments may be made tax-free?
The first £30,000 of any non-contractual compensation paid to you by your employer as a result of the termination of your employment may be tax-free. This includes any compensation for:
- unfair dismissal
- unlawful discrimination
- a statutory or enhanced redundancy payment
- payment for non-contractual benefits in kind; and
- a payment for damages for breach of contract. This can include a payment made by your employer in lieu of notice provided there is no contractual right to do so or when there is no custom and practice by your employer to pay in lieu of notice tax-free.
Any sum paid as compensation that is over £30,000 will normally be subject to income and national insurance deductions.
Compensation for discrimination and personal injury
Compensation payments linked to discrimination or disability claims may also be paid without any tax or national insurance deductions. Special care has to be taken when working out if any tax is payable. Compensation for ‘injury to feelings’ arising from a discrimination claim that is unrelated to termination of employment may not be taxable. This applies even if the employee is paid other compensation, say for loss of net income, which exceeds £30,000. However, compensation for injury to feelings that is connected to the termination of employment is likely to be taxable, following the most recent case law on this issue. It is possible to apportion sums but care must be taken and this is a key area of where the expert advice from Quantrills can make all the difference.
Compensation for any personal injury is normally paid gross without any tax or national insurance deductions, again, even if other compensation exceeds £30,000.
Payments for legal fees, outplacement and re-training
Payment of legal fees and VAT and outplacement counselling will not normally attract tax subject to certain conditions, including payment being made direct to the provider of the service. At Quantrills we will make sure your settlement agreement correctly deals with this issue.
Payments into a pension scheme
Your employer may be allowed to make tax–free payments into a registered pension scheme that you are a member of. If the amount paid into the scheme is below your annual allowance and your lifetime allowance limit then the payment should avoid being taxed. Special rules apply which we will advise you about.
Employee’s tax indemnity and advanced clearance
Your employer is likely to require you to accept liability for tax payable on the compensation payments paid under the settlement agreement which is not deducted at the time of payment to you. Hence, almost all settlement agreements include a tax indemnity in favour of the employer from the employee. Making sure the wording is no more onerous than is necessary is a key part of our work when negotiating the terms of a settlement agreement for a client.
If payments are large, and your potential liability significant, you (and your employer) may want assurances that the payments do not attract tax. You can ask your employer to seek clearance from Her Majesty’s Revenue and Customs (‘HMRC’) in relation to certain payments. If HMRC gives advance clearance it cannot, at a later date, seek to recover tax on those payments.
Reasons to Choose
Expert help from Solicitors
Jargon Free Advice
Convenient Easy Access
Best Client Care
Becoming our client is a straightforward process. However, before choosing Quantrills as your employment law solicitors you and us will want to be completely sure we are the right people to help you achieve your objectives. Having looked at our web site, if you like our approach and would like to discuss how we can help you, getting started is easy.
At Quantrills we are flexible in how we work with you and how we progress your case...
We welcome calls from our clients. Call us any time between 08.30AM to 5.30PM Monday to Friday to discuss your case. We will do our best to speak with you when you call, or if we can’t, you will get a call back as soon as possible.
01473 688 100Or request a call back
If it’s more convenient for you do come and see us. We do an excellent coffee. Whilst many of our clients don’t visit us, our offices are easy to find being just off junction 56 on the A14. Client meetings are by appointment and there is free car parking in front of our reception.Get Directions
We love emails; they help save time and avoid delays. Our case management system is set up to make the best use of them.Email us
Our web forms make it easy to give us the information we need from you. Our forms have a clever "save and return" feature so you can complete the form in more than one visit.View Forms
Latest Employee Knowledge Bank Articles
Use our knowledge bank of employee focused briefing notes, checklists and case reports to obtain trusted and accurate information about key employment law and HR topics to help you learn more about your employment law rights.View more