This is the fourth blog in our series ‘simplifying settlement agreements’ where we tackle these agreements clause by clause and give you the essential information in a nutshell. Our director Cathy Donald explains the key aspects of tax clauses and what to look out for in our first blog on tax.

Do I have to pay tax on money which I receive under a settlement agreement?

It depends on the type of payment. Contractual payments, such as payments in lieu of notice or accrued holidays are taxable and the tax will be deducted at source by your employer. Similarly, sums earned as commission or bonus during employment will be taxable. Money which you receive as compensation for the termination of your employment, including statutory and contractual redundancy payments, is tax-free up to £30k

Be careful if you are signing up to new confidentiality obligations or post-termination restrictions in a settlement agreement – if so, HMRC may regard part of the compensation sum as payment for those undertakings and therefore taxable. In those circumstances we recommend allocating a specific amount to those obligations. That amount will be taxable but will reduce the risk of HMRC applying its own assessment of the value of those undertakings.

My employer has agreed that I may keep my work laptop as part of the severance package – is there a tax implication here?

Yes, this may be taxable if the cash equivalent of the laptop along with other compensation which you receive exceeds £30k. It is usual to agree the cash equivalent of the item being transferred with your employer. Whilst it may be tempting to apply a nominal value, it is safer to agree a realistic value.

My employer is writing off a loan which I owe to the business as part of the severance package – can this fall within the £30k exemption?

No, HMRC will regard the loan as earnings and therefore taxable. In this case, the tax will not be deducted at source; rather, your employer will notify HMRC of the write-off on your P11D form. If possible, it may therefore be better to repay the loan and increase the ex-gratia payment instead.

Are there any ways of reducing the tax being paid?

Your options for reducing the tax on payments under a settlement agreement are limited but, if you can afford to do so, you might consider diverting part of the payment into your pension.

For information on how tax is calculated on termination payments, please see here: www.ergolaw.co.uk/blog/2021/3/12/settlement-agreement-series-5-tax-2

Want to know more?

If you have been offered a settlement agreement by your employer, we would be happy to guide you through the process. Our team of employment solicitors is highly experienced in advising and negotiating on settlement agreements, providing specific expert advice tailored to your particular circumstances. Contact us at info@ergolaw.co.uk or on 0131 618 7007 to ensure that you are well informed and achieve the best possible deal in your circumstances.

You can also find out more about settlement agreements here or take a look at our other blogs in the simplifying settlement agreement series.