Often, we will get asked, can you still make a tax free payment under a settlement agreement? The answer to this question is not as simple as it used to be. Before April 2018, employers could offer their employees a termination payment of up to £30,000 tax free. Anything up to this amount was counted as a voluntary payment made by the employer. Sometimes it was referred to as an ex-gratia payment, which literally translates to mean ‘by favour’. The amount was typically paid alongside the signing of a settlement agreement, which prevented the employee from making a claim covered by the agreement (which must be in writing) to an employment tribunal.
Most settlement agreements are offered as an incentive for an employee to leave the organisation without making a fuss. Employees would accept the amount and then leave without working their notice, and the employer would be exempt from paying tax on the amount given, and would not have to pay Income Tax or National Insurance Contributions on the employee’s notice period, because there was usually not one.
But this is not possible anymore. Now, all payments in lieu of notice will be treat as earnings, and employers will be required to pay Income Tax and National Insurance Contributions against them as though their employee had worked their notice period.
I am an employer, how will tax free payment affect me?
The loophole that allowed you to minimise the amount of tax due when you previously used a settlement agreement to sever a contract no longer exists. As an employer, you’ll now need to work out how much basic pay the employee would have earned had they served their notice period, and this will be considered taxable income. It will be deducted from the £30,000 tax exempt threshold and will be taxable.
How does it affect me as an employee?
You’ll need to be aware that any payment in lieu of notice you are offered will be subject to Income Tax and National Insurance Contributions. If you’re negotiating then you’ll need to take this into account, as the amount you’re offered by your employer could significantly reduce once these contributions have been deducted.
What about redundancy?
Statutory redundancy payments remain exempt from both Income Tax and National Insurance Contributions, but this is not a way around the new rules on settlement agreements. Redundancy procedures must be robust and implemented properly. By the time you’ve invested staff time in taking your employee through the correct redundancy process you’d probably have been better off paying the tax contributions on settlement agreement.
If your main reason for considering making someone redundant over offering them a settlement agreement is tax avoidance, don’t do it.
Can we get out of this?
If you’re an employee, you can avoid losing any of your settlement agreement by working your notice period, but the viability of doing this will obviously depend on the nature of your employer. They’ll have to pay you a salary for the extra weeks you work, and they’ll still have to make Income Tax and National Insurance Contributions on your behalf.
If you’re an employer, we’re afraid there’s no way around the new rules. Depending on the nature of your employee and the circumstances around your settlement agreement, this may mean that you need to offer them a higher sum in order that they agree to sign your agreement.
We can help with settlement negotiation. For more information, please contact JMR Solicitors on 0161 491 3933.