Compromise Agreement and Tax

Ordinarily as part of the terms of a compromise agreement an employee may collect consideration for unemployment which is more than the minimum amount as stipulated by the government that a holder of office is entitled to by the state.

To determine whether tax is owed on fundscollected as compensation for redundancy, this certainly depends on whether the various components, that make up that compromise agreement payment is a payment by the employer in return for work performed under your employment contract. From the view point of an employee, unforunately this will mean that tax may become due, should the Income Tax (Earnings & Pensions) Act 2003 come into effect.

PILON is a contractual right to pay an employee a lump sum rather than require them to work out their statutory or contractual notice period. If there is no PILON clause in a contract of employment then an employer who pays an employee a lump sum salary payment instead of requiring them to work their period of notice will technically be in breach of contract but the employee will usually have suffered no loss. It should be noted that PILON may be taxable. The reasoning is that an employee has a contractural right to continue receiving payment for services.

Looking at this from another perspective, say an employer decides to compensate an employee for loss of office, if for example, this provides for a payment which is not due under the original employment contract, tax implications need to be considered.

In order to determine whether tax is due on the termination sum, a qualified legal advisor will check to see if it is a payment made under contract. HMRC will consider the payment as taxable if the contract or practice of the employer provides the employee a legal right to obtain a sum of money when employment is terminated.

If there is any doubt whether tax is payable on all or part of a payment within a redundancy compromise agreement, Revenue and Customs may ask to see the employee's contract of employment and any other documentation for it to decide whether there was a contractual entitlement or a practice by the employer to give certain payments on termination of employment. This may be a cause for concern to an employee because even if there is a reasonable expectation of a contractual right to a settlement sum, the government may still make a claim.

Up to £30,000 of a legitimate settlement sum is tax free. This is provided for in current government legislation. It is important however, to remember that in order to enjoy the full exemption, none of the settlement payment can arise from a contractual right. What if the settlement sum exceeds £30,000? In this situation, any excess will be taxed at the usual income tax rate.

If this is of interest to you, please follow this link for more information:
Compromise agreements