Termination Payments, Settlement Agreements and Tax
The Budget in March 2016 announced compulsory national insurance contributions (NICs) on compensatory payments over £30,000.
The taxation of payments made under a settlement agreement can be complex. Payments can often be made free of tax and NICs where the payment is compensation for loss of employment, up to a maximum of £30,000. At present, compensatory payments over £30,000 are taxed but do not attract NICs. From 6 April 2018 termination payments will only be free of tax and NICs up to the value of £30,000, and compensatory payments over £30,000 will now attract both tax and NICs.
Payment in lieu notices
A payment in lieu of notice (PILON) is taxable if there is a contractual right to a PILON in the employee's contract of employment. If there is no contractual right to a PILON, the payment would be compensation for the abrogation of the employee's right to notice, and therefore would not attract tax or national insurance.
Usually, compensatory payments are paid as part of a settlement agreement which is a legally binding document which sets out mutually agreed terms and conditions to settle a potential employment tribunal claim or claims, or other court proceedings.
Settlement agreements are normally used when bringing an employment relationship to an end in a way agreed by both the employer and employee to reach an agreed conclusion to a workplace dispute.