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Compromise Agreement and Tax

21st December 2009
By Stefan Valenzuela in Taxes
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Very often as part of the terms of a compromise agreement an employee may collect payment for unemployment which rise above the statutory minimum amount that an employee is designated to by the government.

To determine whether tax is due on fundsreceived as consideration for redundancy, in many ways this depends on whether the various components, that make up that termination payment is a payment by the employer in return for work performed under your employment contract. If the payment or part of that compensation is for services rendered, then this element of the compensation will be taxable under the Income Tax (Earnings & Pensions) Act 2003.

PILON is a contractual right to pay an employee a lump sum rather than require them to work out their statutory or contractual notice period. If there is no PILON clause in a contract of employment then an employer who pays an employee a lump sum salary payment instead of requiring them to work their period of notice will technically be in breach of contract but the employee will usually have suffered no loss. It should be noted that PILON may be taxable. The reasoning is that an employee has a contractural right to continue receiving payment for services.

Lets consider another scenario, say an employer decides to compensate an employee for loss of office,

So, to understand whether tax is due on an employee's termination payment, the starting point is to ask whether the termination payment is contractual i.e is the employee entitled to the payment under contract. The tax authorities will look to see if there is a contractual right for an employee to claim the settlement sum and consider the general practice of the employer when considering whether a settlement sum is taxable.

It is difficult for an employee to claim that a settlement sum is not taxable. The government will conduct an investigation to the merits of the case by inspecting in detail the employment contract and other supporting documentation. This may be a cause for concern to an employee because even if there is a reasonable expectation of a contractual right to a settlement sum, the government may still make a claim.

Up to £30,000 of a legitimate settlement sum is tax free. This is provided for in current government legislation. It is important however, to remember that in order to enjoy the full exemption, none of the settlement payment can arise from a contractual right.

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Compromise agreements
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