London: 020 7247 7190 Manchester: 0161 850 4095 Preston: 01772 369 450 Birmingham: 0121 728 6518
London: 020 7247 7190 Manchester: 0161 850 4095 Preston: 01772 369 450 Birmingham: 0121 728 6518

Are Payments for Settlement Agreements Tax Free?

Settlement Agreements are contracts between employer and employee to bring a workplace dispute to an end without legal proceedings. Employees must have independent legal advice from an appropriately qualified person, which includes practising solicitors. Once signed, an employee cannot make a claim at an Employment Tribunal. A settlement agreement generally provides for payment of a sum of money from the employer to the employee.

If offered, or offering, a Settlement Agreement it is clearly important to understand the tax implications of what is on offer especially as this is an area that can, and has, changed recently.

Calculating the tax that might be payable on a settlement (compromise) agreement is not always straightforward. Settlement payments of up to £30000 are usually tax-free though this does not apply to all payments and the tax implications of any payment need careful consideration. The treatment of some of the elements that often form part of a settlement is set out below.

Types of Settlement Agreement Payments

Salary and Benefits

Payments made up to the end of the contract of employment are subject to income tax and national insurance as they are part of normal earnings.

Holiday Pay

Any holiday pay is taxable as usual.

Payments in Lieu of Notice (PILON)

Payments in lieu of notice have been subject to changes of treatment recently and are subject to tax and national insurance (whether contractual or not).

Compensatory and Ex-Gratia Payments

Non- contractual payments made for loss of employment are exempt from tax on the first £30000.


Both contractual redundancy payments and statutory payments fall within the £30000 exemption.

Pension Contributions

Payments made direct into pension schemes are separate from the £30000 exemption and they are not normally subject to tax though there are limits to the annual and lifetime allowances for contributions.

Outplacement Services

Contributions to outplacement services are not taxable and do not count towards the £30000 exemption. These payments are likely to be made direct to the outplacement provider.

Payment on Account of a Disability

When a payment is on account of a disability, injury or death the payment is tax free.

Injury to Feelings

Termination payments for injury to feelings attract income tax unless the injury arises from unlawful discrimination.

Legal Costs

Payment of legal costs by an employer, direct to an employee’s solicitor, in respect of a settlement agreement is not usually subject to tax as long as it is solely in connection with the termination of employment.

Recent Changes Involving the Tax Treatment of Settlement Agreements

Not only is this area of very complex, it is currently in a state of flux. Changes came into play in April 2018 which changed the approach in terms of tax in relation to certain types of payment.

Firstly, in order to understand what payments will attract tax, it is important to understand that payments under a settlement agreement will be of different types.

For example, if the payment relates to salary owed to you before the end of your contract of employment, this will attract tax. It is essentially just a payment of salary in the ordinary course of employment and therefore is taxed as salary normally would be. Holiday pay would also receive similar treatment. On the other hand, statutory redundancy payments are not liable to tax, up to £30,000. It is therefore important that you understand the distinction between different types of payment to understand when tax is owed.

The recent changes to the regime came in as of April 2018. The changes relate to payments paid in lieu of notice which are all now liable to tax and national insurance.

Clearly it is important that you understand the context of the settlement agreement and what each payment relates to. It can be a confusing process – apportioning and calculating payments – however, our expert employment lawyers are on hand to offer guidance throughout the process. If you do not seek tax advice, you could be liable to an unexpected payment. It is therefore crucial that you seek appropriate advice.

Contact Our Specialist Employment Solicitors in Canary Wharf, London, Birmingham, Manchester & Preston

At Gordon Turner Employment Lawyers, all we need is a copy of the Settlement Agreement and your telephone number and we can help by return.

With the right advice you can ensure you understand any tax liability and fully partake in the negotiations.

Call us or fill in our form now and take the first step to resolving your issue:

London: 020 3962 1665 Manchester: 0161 850 4095
Preston: 01772 963 039 Birmingham: 0121 728 6518