ON THE CASE - Tax in settlement agreements

Some payments made to an employee in a settlement agreement, will be subject to income tax and national insurance contributions (NICs) and some may be paid tax free.  As a general rule, payments for injury to feelings for discrimination occurring during employment that don’t relate to the termination of employment, and ex-gratia payments under £30k for loss of office, may usually be paid tax free.  Any payment made in lieu of the employee’s notice period is subject to tax and NICs at the employee’s normal rate.

If the employer introduces a new contractual term into the settlement agreement, such as a new post-termination restriction, then separate consideration must be provided, and that payment will be subject to income tax and NI.

A recent ruling in a tax case heard in the first-tier tax tribunal, has highlighted that an undertaking to maintain confidentiality and non-disclosure of the agreement, is a new obligation and should, therefore, be subject to tax and NI.

A v The Commissioners for HM Revenue & Customs - Mrs A entered into a settlement agreement with her employer and received a substantial payment.

Her settlement payment comprised three elements.  Each had a different tax treatment.

• Six equal monthly payments following the date of the settlement agreement. These payments represented pay in lieu of her notice period, treated as fully taxable and subject to NICs, and were paid through PAYE.
• £45,000 for injury to feelings and aggravated damages in full and final settlement of the claim, paid tax-free. This tax treatment was agreed by HMRC (and the Tax Tribunal).
• £1 million as compensation for the termination of her employment and any and all claims she may have against the employer and other related persons.

The settlement agreement went on to contain standard terms with the employee agreeing (among other things) to withdraw the tribunal claim, not to bring other claims, and agreeing to confidentiality and non-disclosure obligations and an agreement not to make derogatory statements about the employer or related persons.

The Tax Tribunal held that any payment in connection with any restrictive agreement (such as non-disclosure) given in connection with past, current or future employment, a much broader test, was caught as a relevant taxable payment.