Settlement Agreement - tax rules

[A900ss]

Hi,

Can somebody who has some knowledge give me a little guidance on tax/ni for settlement agreements?

Assuming a 3 month notice period.

Also assume 6 months total pay off plus £10k out of £20k annual bonus agreed as settlement.

Payment in lieu of notice (it's in the contract) - 3 months taxable?

Remaining 3 months payment - not taxable?

£10k of bonus payment (assume paid as a settlement figure rather than a bonus payment) - not taxable?

Any confirmation of the correct taxable/non taxable status is gratefully received.

[BenjiA]

Yes, you've got that right, but make sure the bonus is part of the settlement not as part of your normal contract otherwise it would be taxable. Good luck.

[Eric Mc]

Is it really a "bonus" but being deliberately classified as something else in order to avoid tax?

Why are you receiving it?

[A900ss]

Eric Mc said:

Is it really a "bonus" but being deliberately classified as something else in order to avoid tax?

Why are you receiving it?

I'm part of a management team that gets an annual bonus subject to company performance (which was deliverd). Qualifying period is Jan - Dec but paid out in following March.

As I potentially won't be an employee in March they won't pay me the bonus so this will be a payment half of what I'm entitled to.

However it would not be referred to as 'bonus' in the settlement.

So it's a payment to cover loss of bonus - taxable or not?

Thanks.

[Eric Mc]

Is it the equivalent of the bonus and will it be calculated with reference to how they would have calculated your bonus?
In other words, how are they arriving at the "settlement" figure?

Just calling it something else is not going to work. It needs to be shown that it is not a bonus in REAL terms as well.

[JNW1]

A900ss said:

Hi,

Can somebody who has some knowledge give me a little guidance on tax/ni for settlement agreements?

Assuming a 3 month notice period.

Also assume 6 months total pay off plus £10k out of £20k annual bonus agreed as settlement.

Payment in lieu of notice (it's in the contract) - 3 months taxable?

Remaining 3 months payment - not taxable?

£10k of bonus payment (assume paid as a settlement figure rather than a bonus payment) - not taxable?

Any confirmation of the correct taxable/non taxable status is gratefully received.

Interested in this as I'm about to part company with my existing employers. As part of a restructure they put a group of us through a "selection process" with some us made redundant as a result; however, it seems clear that a number of the appointments were pre-determined and there's evidence to support that (for example a structure chart with names against roles before the interview process was even complete). On that basis I think there's a strong argument that it's unfair dismissal rather than redundancy but if that were proved to be the case what would the tax position be on any resultant settlement agreement? Think I'd be saying I want at least 6 months to compensate for my loss with the first £30k tax-free but is that a reasonable stance to adopt? In practice this wouldn't actually cost my company much more than the redundancy settlement being proposed as they're giving 4 months already (being 3 months PILON per my contract plus one month of salary as redundancy); however, the different tax treatment associated with a settlement agreement for unfair dismissal would obviously make a significant difference to what hits my bank account. If there are any employment law experts out there your views would be much appreciated!

[Number 7]

Assuming that the agreement will include some restrictive covenants, it's worth incorporating a sum (£100 say) as consideration for you agreeing to these. This will be taxable, but it should avoid the possibility that HMRC view the entire ex gratia sum as being the consideration. You will almost certainly be required to take formal legal advice (to protect the company) which they should pay for (maybe £500 + vat) so talk to your lawyer about this.

[bladerrw]

Just been through this and Number7's comment is exactly what was settled for - £500 for legal costs and £100 covering the restrictive covenant to keep everything confidential. If I am understanding it correctly, this £100 is all that is at stake if the dismissed employee tells the world how they have been shafted by the employer. Whereas the remaining XXk is compensation for giving up the right to sue for unfair dismissal.

I was surprised how low the statutory unfair dismissal calculation and the total cap is. Seems at odds with the 6 figure payments poor performing civil servants are reported to walk away with.

[JNW1]

Number 7 said:

Assuming that the agreement will include some restrictive covenants, it's worth incorporating a sum (£100 say) as consideration for you agreeing to these. This will be taxable, but it should avoid the possibility that HMRC view the entire ex gratia sum as being the consideration. You will almost certainly be required to take formal legal advice (to protect the company) which they should pay for (maybe £500 + vat) so talk to your lawyer about this.

bladerrw said:

Just been through this and Number7's comment is exactly what was settled for - £500 for legal costs and £100 covering the restrictive covenant to keep everything confidential. If I am understanding it correctly, this £100 is all that is at stake if the dismissed employee tells the world how they have been shafted by the employer. Whereas the remaining XXk is compensation for giving up the right to sue for unfair dismissal.

I was surprised how low the statutory unfair dismissal calculation and the total cap is. Seems at odds with the 6 figure payments poor performing civil servants are reported to walk away with.

Thanks both, broadly confirms where I thought I'd be if compensated for unfair dismissal although at the moment my employer is yet to admit their selection process was flawed. Clearly I'm biased but I think it's quite difficult to claim outcomes weren't at least in part pre-determined when you've created a final structure chart before the interviews were complete; other issues have been highlighted with the process as well but at the moment they seem to sticking to a line that they've done everything correctly and hence I fear it may all have a way to run!

[Number 7]

bladerrw said:

If I am understanding it correctly, this £100 is all that is at stake if the dismissed employee tells the world how they have been shafted by the employer. Whereas the remaining XXk is compensation for giving up the right to sue for unfair dismissal.

I don't believe that is correct. My experience (IANAL) is based on 4 similar situations involving me and Mrs. Number 7 over the past few years. It is solely a mechanism to avoid HMRC possibly treating the entire ex gratia payment (for loss of office) as taxable. It does not limit any liabilities arising from a breach of the compromise / settlement agreement.

[Jasandjules]

Would need to know a little more but there are a couple of things which can be done to reduce tax liability.

If you want to send me an email

[JNW1]

Jasandjules said:

Would need to know a little more but there are a couple of things which can be done to reduce tax liability.

If you want to send me an email

My understanding is that if you have a PILON clause in your contract - and it's a genuine redundancy situation - then the PILON is taxable and there's not really anything you can do about it? However, my feeling is that I'm really in an unfair dismissal situation (because of the way my employer has run the process) and hence if I'm offered compensation for that my question was more around the resultant tax implications; my hope is that the PILON clause in the contract becomes irrelevant in that scenario and therefore more of the settlement potentially becomes tax-free? However, the whole thing is hypothetical unless and until my employer acknowledges they've made a mess of the process and is prepared to discuss a deal - if they refuse it could go all the way to a tribunal although I sincerely hope not.....

[Jasandjules]

There are some payments which can be made to reduce tax liability to zero below 30k. However you need to word it carefully as otherwise HMRC get interested.

I trust this is looking to be a compromise agreement and not a COT3?

[JNW1]

Jasandjules said:

There are some payments which can be made to reduce tax liability to zero below 30k. However you need to word it carefully as otherwise HMRC get interested.

I trust this is looking to be a compromise agreement and not a COT3?

My hope is that I'll end-up with a reasonable compromise agreement (or settlement agreement as they now seem to be called!). I don't know anything about COT3's but a quick search on Google seems to suggest they're a settlement agreement reached with the help of ACAS? I've not involved ACAS thus far but that's obviously an option if the company don't want to settle amicably; however, your response seems to suggest a COT3 is not the preferred option so what are the disadvantages of those compared to conventional compromise agreements?

[Jasandjules]

A COT3 has advantages in that they are quick and generally simple.

A compromise agreement/settlement agreement will require a lawyer to go through (usually this cost is met by the employer though) and then you both sign it.

In both however you agree to sign away all your rights to sue your employer for the breaches contained therein. And in both you need to correctly word certain matters in order to ensure HMRC has minimal claims for tax.

[JNW1]

Jasandjules said:

A COT3 has advantages in that they are quick and generally simple.

A compromise agreement/settlement agreement will require a lawyer to go through (usually this cost is met by the employer though) and then you both sign it.

In both however you agree to sign away all your rights to sue your employer for the breaches contained therein. And in both you need to correctly word certain matters in order to ensure HMRC has minimal claims for tax.

Thanks, that's useful information! I may have misinterpreted your previous post but when you said "I trust this is looking to be a compromise agreement rather than a COT3" I took that to mean that the former was in some way preferable to the latter; however, do both achieve the same end, one via a lawyer and the other via ACAS? If my employer accepts they've got it wrong it will probably never get as far as ACAS in which case I see the compromise agreement - and advice from a lawyer - being the more likely scenario. If I understand correctly it sounds like either a compromise or a COT3 has the potential to be more tax efficient than PILON plus redundancy and it just needs someone who knows what they're doing to draw-up the agreement with the correct wording?

[Jasandjules]

JNW1 said:

If I understand correctly it sounds like either a compromise or a COT3 has the potential to be more tax efficient than PILON plus redundancy and it just needs someone who knows what they're doing to draw-up the agreement with the correct wording?

Well, I said that because I took it to be the case that your employer was already starting the ball rolling and employers tend to prefer a more complete (and ideally watertight) compromise agreement.

Well, a settlement agreement of any kind can have payments made to be tax efficient (in your favour), therefore I would suggest you instruct someone to act on your behalf or at least advise you of what to tell them to include....... Insured advice...

[JNW1]

Jasandjules said:

Well, I said that because I took it to be the case that your employer was already starting the ball rolling and employers tend to prefer a more complete (and ideally watertight) compromise agreement.

Well, a settlement agreement of any kind can have payments made to be tax efficient (in your favour), therefore I would suggest you instruct someone to act on your behalf or at least advise you of what to tell them to include....... Insured advice...

Appreciate your input! My employer is yet to concede they've made a mess of it all but a number of senior people have appealed the redundancy decisions made on the basis at least some appointments were pre-determined and therefore the selection process was unfair; I'm hoping things will move towards a satisfactory conclusion this week although the way the process has gone so far I'm not holding my breath.....

[Jasandjules]

You could ask to have a "without prejudice" discussion and set out your position.

[JNW1]

Jasandjules said:

You could ask to have a "without prejudice" discussion and set out your position.

I've submitted an appeal but made clear I'm not seeking a reversal of any decisions on the basis the appointments obviously reflect who the company want in the new team and I have no desire to work where I'm not wanted. However, I've also said that I believe the outcome of the selection process was at least in part pre-determined (and therefore unfair) and hence what I am seeking is acknowledgement of a flawed process together with an appropriate revision to the severance package. In the appeal letter I've made reference to some of the evidence in my possession (e.g. the Final Structure chart which was created before the interview process was complete) but as yet I haven't provided copies (not sure if it's something I should offer in an appeal hearing or save for a tribunal?). Late this afternoon I received a date and time for my appeal (this Thursday) but clearly I would prefer to avoid going through that and potentially a tribunal; therefore, do I offer the company the option of a "without prejudice" discussion before the appeal takes place or suggest that during the appeal hearing? To be honest I think my appeal letter makes it pretty clear what I see as an acceptable outcome and in some respects I was half hoping the company would have reacted to that and approached me with the suggestion of a "without prejudice" discussion; however, that could just be naivety on my part as I've never been involved with anything like this before (as you can no doubt guess!).