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One thing’s for sure, this is a difficult time for everyone involved, so the last thing you need is Accounting and Tax rules making things even more difficult than they need to be. The rules here are not that simple, but with the right advice, they don’t need to make the process any harder, for employers or employees.
What is a Settlement agreement?
A settlement agreement is a legally binding agreement between employer and employee and can be used in several different situations. Its purpose is to allow both parties to end an employment relationship, with the employee waiving their rights to bring a claim against the employer, in the process.
As compensation, the employer will usually have agreed a sum of money that the employee will receive, potentially above and beyond the statutory minimum.
Which payments are taxable, and which are tax-free?
The settlement agreement will need to detail specific payments to be paid to the employee, including any ex-gratia/compensation amounts. The types of payments below illustrate the variations of taxable and non-taxable payments:
- Ex gratia payments: First £30,000 of an ex gratia/compensation payment is tax-free. Anything in excess of £30,000, will be subject to tax and NI;
- Salary, benefits and bonuses: As contractual payments they are subject to tax and NI in the normal way;
- Holidays: Accrued holiday is subject to the normal tax and NI;
- Payment in lieu of notice (‘PILON’): This will need to be taxed as normal salary, whether or not there’s a PILON clause in the contract of employment;
- Pension: When made directly into the pension scheme the payment doesn’t need to be taxed;
- Redundancy: Contractual and statutory redundancy payments are considered as part of the £30,000 payment and also exempt from tax up to that amount;
- Restrictive covenants payments: These tend to be nominal amounts but still liable for tax and NI deductions;
- Injury to feeling payments: When arising from unlawful discrimination that happened before the termination, it won’t be taxed; if caused by the termination it will be; and
- Legal fees: If incurred by the employee pursuant to a specific term in the settlement agreement and for the termination of the employee, these fees would not be taxable, although payment is usually made directly from the employer to a legal representative.
Because these can be quite complex, we would recommend you either check the tax treatment yourself or speak to a professional. They are often miscalculated, even by big corporations and you want to make sure you are not paying more tax than you need to.
What next – making the most of redundancy
It might not feel like it at the time, but everything happens for a reason and if you have lost your job, it’s a great opportunity to re-assess what you are doing and what you want to do in the future. Have you considered starting your own business? Do you have a business idea which you want to make a reality? If so, we’d love to hear more about it.
P11Ds
As a quick watch-out for employees, if you receive any benefits-in-kind, such as company car, private health care or insurance from your employer, and receive and pay this after the year end (as opposed to it being payroll’d), please be aware that you might receive a request from HMRC to pay this after you leave your position. If you have not been able to find a new opportunity, this can be particularly painful. If you really cannot afford to pay this, we recommend speaking to HMRC as soon as possible and trying to arrange a payment plan. Communication is key and the earlier you flag this, the better.
Black and White Accounting: expert tax advice
Tax arrangements under a settlement agreement can be complicated. To ensure you aren’t subject to HMRC penalties and interest for not making the correct tax and NI payments, seeking expert advice on taxable amounts will give you peace of mind.
On a different note, if you are an employee who has lost their position, but have a business idea, which you want to talk through with someone, we’d love to hear more and help you make it a reality.
If you would like more detailed information about taxable payments under a settlement agreement that’s tailored to your specific circumstances, want to check any calculations of the consequences of these that you have been provided with, or have a great business idea, then our specialist team at Black and White can help you. Contact Black and White Chartered Certified Accountants today or call us on 0800 140 4644.
