settlement agreement money questions (picture of money)

Case Study: Is ex-gratia compensation all tax-free?

Here is a case study of a real client we advised recently – last week in fact.

Sam’s (not his real name) employment was being terminated. There’s had been a few issues he wasn’t happy with and he had already started looking for a new job. He had raised a couple of informal grievances with line managers and the company generally, one of which was quite critical of the company.

He was therefore presented with the possibility of that being a disciplinary issue, that he could not make disparaging or derogatory comments about his employer.

Now, we know the truth is that it was not a real disciplinary matter, any such process was just a sham and the truth was that his face no longer fit – the Company wanted him out.

Anyway, they had made a suitable compensation offer to terminate his employment and given that Sam had been unhappy anyway and looking elsewhere, he was prepared to accept the deal.

On reviewing the settlement agreement, the Employer had apparently bundled together Sam’s contractual notice pay and the compensation payment into one “tax-free” figure.

However, the law does not permit that. Where any aspect of payments made under a settlement agreement are in relation to notice pay, that amount should be taxed in the usual way.

If you’re interested (I know you’re not!!) it is because of the Income Tax (Earnings and Pensions) Act 2013 and HMRC Guidance on it. But cut short, any Post-Employment Notice Pay, or PENP, is taxable.

Back to Sam, the draft agreement did not refer to the Payment in Lieu of Notice (PILON) which meant the effect was that all of the “tax free” payment would be at risk of investigation by HMRC, and then taxable with interest and penalties likely added on.

As Sam’s Settlement Agreement Solicitors we advised him to instruct us to negotiate a revised deal including revising the words of the agreement.

We successfully did so. Yes, it will mean that extra tax is paid, but that is right. We were able to get an additional sum which more than paid for the tax and an extra compensation sum. It also meant that there ought to be no risk that HMRC levy additional sums for tax avoidance.

The client was happy.

Moreover, the advice on the settlement agreement was turned around within 24 hours and a meeting in place.

If you have a settlement agreement and are concerned about the tax position, the tax indemnity within the agreement or any aspect of PENP and PILON pay, then get in touch.

Free No Obligation Call

Contact us now for your free no obligation call with a settlement agreement solicitor.

Related Posts