Settlement agreements (previously called compromise agreements prior to 29 July 2013) are in some circumstances taxable.
A termination package in a settlement agreement will typically comprise various contractual and non-contractual elements, some of which may or may not be liable to income tax, may be tax-exempt and some of which may attract extra-statutory tax concessions allowable by HM Revenue and Customs. The circumstances that brought about the termination of employment are a key factor that can further complicate the tax position. Employers must first determine the reasons for the payment and then progress to look at the taxation.
The Current Position
Generally, payments chargeable to income tax under section 62 of the Income Tax (Earnings and Pensions) Act 2003 include:
- outstanding salary payments and holiday pay;
- other earnings derived from employment such as outstanding bonus or commission payments; non-cash benefits in kind, such as the retention of a company car;
- other payments made under the employee’s contract of employment; a contractual payment in lieu of notice or pay received while on garden leave;
- a payment to induce the employee to enter into or abide by post-termination restrictive covenants;
- and payments given in connection with termination of employment that cannot be charged to income tax in any other way, to the extent that, as a whole, they exceed £30,000.
There is a £30,000 exemption in section 401 of the Income Tax (Earnings and Pensions) Act 2003 in respect of those elements of the termination package not otherwise chargeable to income tax that are received in consequence of the termination of employment.
The first £30,000 of the following payments benefits from the tax exemption referred to above:
- statutory, contractual and ex-gratia redundancy payments made on account of genuine redundancy; and
- non-contractual ex-gratia payments made as compensation for loss of employment including unfair dismissal etc.
What this means is that currently, employees with contractual rights to pay in lieu of notice payments are taxed, while non-contractual pay in lieu of notice payments can qualify for the £30,000 exemption. This current rule has been criticised as unfair and viewed as adding unnecessary complexity.
In addition to consideration about tax payments, all schools must consider the fact that public money is being used to terminate employment and this cannot be seen as financial payment for gross misconduct or under-performance.
Academy Trusts have delegated authority to approve individual staff severance payments provided any non-statutory/non-contractual element is under £50,000. Where the Trust is considering a non-statutory/non-contractual payment of £50,000 or more, prior approval must be obtained from the EFA before the Trust makes any binding settlement offer to staff.
Academy Trusts should demonstrate value for money by applying the same level of scrutiny to a payment under £50,000 as if it was over the £50,000 delegation and have a business case justifying the level of settlement reached. Settlements must not be accepted unless they satisfy the conditions of the Academies Financial Handbook, 2016.
Possible Future Changes
The Government has announced that changes to the rules on taxation of termination payments will come into force from April 2018. Under proposals on which it is currently consulting, all termination payments that would have been treated as general earnings if the employee had worked his or her notice period will be subject to tax and national insurance; all payments in lieu of notice, whether contractual or not, will also be subject to tax and national insurance and the £30,000 exemption will apply to payments relating directly to the termination of the employment.
If you would like to know more about termination payments or settlement agreements please contact your HR Advisor or one of the Fusion team on 01924 827869. We also have two training events coming up which may be useful to you, Managing Disciplinaries on 24 November and Managing Grievances on 1st December. To see all our training opportunities click here.