New tax rules affect settlement agreements

Pay in lieu of notice must always be taxed, in payments applying to employment terminations made on or after 6 April 2018. Under new tax rules, income tax and class 1 NICs must be paid on the basic pay an employee would have earned if they had worked their notice in full.

This means that it no longer matters whether there is a PILON ('pay in lieu of notice' clause) in an employee's contract of employment. Even where there is no PILON, basic pay in lieu of notice (i.e. 'post-employment notice pay') will be subject to income tax and NICs.

Settlement agreements should split a 'relevant termination award' between amounts treated as earnings and amounts benefitting from the £30,000 tax exemption. Employers must treat as earnings any slice of the termination payment that reflects basic pay for any part of a notice period not served.

Statutory redundancy pay still falls within the £30,000 exemption, but non-statutory redundancy pay does not. True ex gratia awards are still potentially exempt up to this limit - but care needs to be taken as to what actually constitutes an ex gratia award. In particular injury to feelings awards are not included except where the injury amounts to a psychiatric or recognised medical condition.

All settlement agreements should be reviewed with the new tax changes in mind. We advise employees daily on the terms and effect of settlement agreements and will always explain the tax implications simply and clearly.

For help and guidance about this area of the law, please contact Wards Solicitors' Employment Law Consultant Solicitor, Julia Beasley.