How will the payments under your Settlement Agreement be taxed?
As a general rule, the first £30,000 of the compensation under your compromise agreement will be tax free. The balance will be taxed according to your usual income tax rate.
Both your contractual redundancy payment and statutory redundancy payment fall within the £30,000 exemption. Once you have reached the £30,000 ceiling for any combination of these payments you will have to pay tax.
Whether or not your notice payment is taxable will depend upon your employment contract. If you have a pay in lieu of notice (“PILON”) clause in your employment contract, your employer is required to make tax and National Insurance deductions. If, however, your contract does not have a PILON clause, and your employer opts to pay you in lieu, this payment can come within the first £30,000 available tax free exemption.
Where there is a custom and practice by your employer to make a payment in lieu of notice, despite the absence of a PILON clause, HMRC may still determine that tax should be deducted, because of their custom and practice.
Your salary, benefits and bonus entitlement payable up to and including the termination date will have tax and national insurance deducted in the usual way, as will accrued holiday pay.
Sometimes, your settlement agreement requires you to comply with new restrictive covenants. In order to make these terms binding and enforceable, your Employer provides a small payment which is often around £100 – £200 and is fully taxable. Some agreements may also contain a small sum to make a confidentiality clause binding, and this too will be taxable.