Case Studies

Settlement Agreement Payments and Tax

on November 8, 2017 Comments Off on Settlement Agreement Payments and Tax

Under the terms of a settlement agreement, you will likely be offered various payments.  Some of these you will be entitled to contractually and some are known as “ex gratia” payments.  Ex gratia payments are voluntary payments.

The payments you will be entitled to and offered carry differing tax implications with them.

Termination Payment

Under the terms of a settlement agreement, it is common for employers to offer an ex gratia payment to the employee.  This is often to take into consideration the financial loss an employee will suffer on termination of their employment. It can also be an incentive to settle any potential Employment Tribunal/County Court claim the employee may against the employer. Such a payment is often referred to as the termination payment.

This is an ex gratia payment as the employer is not obliged to offer such a payment.

Current tax law allows for the first £30,000 of a termination payment to be payable tax free.  This therefore means that there will not be any deductions from the first £30,000 for income tax or national insurance contributions.

If you receive a termination payment in excess of £30,000, only the first £30,000 will be payable tax free, and sums in excess of the first £30,000 will be subject to income tax and national insurance contribution deductions at the appropriate tax band.

Redundancy Payments

Regardless of whether there is provision for a redundancy payment in your employment contract or not, these payments are made free of tax.  This is because a redundancy payment is to compensate the employee for the loss of earnings they will incur on redundancy.

Again, the first £30,000 of a redundancy payment, whether calculated in accordance with statutory guidelines or contractual obligations, will be made free of tax deductions.

There should be a genuine redundancy situation in order to be offered and accept a redundancy payment.  If HMRC later determines that there was not a genuine redundancy situation, it may claim income tax, national insurance contributions and issue any fine or penalty it deems appropriate in the circumstances.

Payments in Lieu of Notice (PILON)

Employees should receive adequate notice to terminate their employment.  If the employer does not require the employee to work their notice period, they may offer a PILON.  The tax implication of such a payment is determined by what the employee’s employment contract says.

If there is a provision in the employment contract for a PILON, then it is a contractual payment and income tax and national insurance contributions are to be deducted from the payment.

If the employment contract is silent on a PILON, it may be possible to class it as an ex gratia payment and therefore can be made free of tax deductions.


Payments for usual wages are treated the same way as every month and subject to tax deductions.

Holiday Pay

Any payment for accrued but untaken holiday allowance is also subject to tax deductions as usual.

Payment into Registered Pension Scheme

If a payment is made directly into a pension scheme, it is usually not subject to tax.  However, if the payment is in excess of the annual allowance, tax deductions will be incurred.


Please note that if you require specific advice in relation to your tax position, you should seek advice from an independent financial advisor.


Call us on to get independent advice before signing a Settlement Agreement

Primal LaxmanSettlement Agreement Payments and Tax