The first £30000 of many settlement packages is exempt from tax by virtue of sections 401 and 403 of the Income Tax (Earnings and Pensions) Act 2003, if the payment is a genuine severance payment rather than a contractual payment. So, a payment for a breach of contract or to settle a potential and genuine Unfair Dismissal claim or discrimination claim fit within the tax free exemption. Anything over £30000 will be taxed at the employee's marginal rate of tax i.e. as if it were the "top slice" of the employee's income for that year.
Any payment that constitutes a contractual payment already due to the employee e.g. notice pay or holiday pay will be chargeable to tax in the normal way. It is important to be aware that notice pay is usually chargeable to tax.
Ideally any Compromise Agreement should be signed after the employment termination date because if it is signed too far in advance HMRC could treat it as a variation of the employment contract and tax the payments made. This isn't always practical and taxing the settlement figure is unlikely if the agreement is signed only a few days before the termination date.
Amounts paid on retirement will usually attract income tax under the retirement rules and will not qualify for the £30000 exemption.
Amounts paid on ill health termination may attract a total exemption from tax but normally the revenue will expect to see medical evidence.
Please note if you require advice on tax matters you should consult an accountant. The matters dealt with above are only a rough guide and may not apply to individual cases.
Contact Tony Wilkinson 0115 8525813
