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Will You Be Liable To Tax On The Severance Package Contained In Compromise Agreements?

By Graham Cardona

Since most compromise agreements contain an indemnity clause placing the burden on the employee to pay any tax on any gross payments received under settlement terms contained in a compromise agreement, it should be an important consideration for every employee.

To properly evaluate the suitability of an employer’s termination package, particularly if you are a higher rate tax payer, you will need to give some consideration to your potential tax liability. You may decide after taking into consideration possible tax liability that the termination package on offer is neither attractive nor adequate. Please bear in mind however that the guidance I provide here is simply that, guidance only to current judicial thinking and understanding. Ultimately, it is for the Revenue (HMRC) to determine on a case by case basis whether tax is due in respect of a termination payment.

The basic tax position is that the first 30,000 of a cash lump termination payment is free of tax. However, the important point here is that this exemption only applies to the compensation element of the severance/termination payment. So, if your termination payment is made up of several components, for example, payments due in accordance with the terms of your contract of employment, such as “payments in lieu of notice” (PILON), holiday pay and any other wages and emollient entitlements pursuant to your contract of employment, this will be taxable in the normal way and ought to be deducted by your employer and paid to you net of tax. If any element of the termination payment can be construed as a contractual entitlement and not as a payment arising because of the termination of your employment, the HMRC is likely to treat this as taxable.

Whether tax is payable therefore depends on how the payment is made up. You will usually have to pay tax and national insurance on any wages, holiday pay and any other contractual payments. It’s therefore possible to improve your tax position by negotiating andre-arranging the way payments are expressed within your Compromise Agreement in order to avoid any ambiguity and inquiry by HMRC. It is advisable to seek professional advice so that your employment contract and any other relevant documentation can be properly considered to ensure that you maximize the use of the current 30,000 exemption to tax.

I hope you will therefore appreciate from my brief explanation above, that it’s simply not correct to assume that all termination payments up to 30,000 is tax free, as is often assumed by some employers, and you ought to exercise some caution before concluding agreement on any severance deal with your employer to avoid receiving an unexpected tax bill from HMRC. Below I have set out the most common elements of termination payments and indicated whether tax is payable:

1. Statutory redundancy payments are included as part of the tax-free 30,000 exemption.

2. Contractual redundancy payments are received free of tax up to 30,000 providing that the payment is for a genuine redundancy situation.

3. Compensation for loss of employment which may be referred to as ex gratia payments, are exempt of tax up to 30,000.

4. Payments in Lieu of Notice or PILON payments are subject to tax if a PILON clause is contained in an employee’s contract of employment. If the contract of employment is silent on the point, then such a payment is unlikely to attract tax. However, if it can be shown that there is a custom or practice of the employer of paying PILON payments when there is no contractual right to do so, HMRC may decide that tax is due on such payments although some Guidance has been provided by the Revenue department to suggest that such payments are likely to be treated as compensation payments and not subject to tax if those payments are part of a process of termination.

5. Payments specifically offered in respect of an employee agreeing to be bound by a post termination restriction such as non-competition will attract tax if the post restriction was not previously stipulated in the contract of employment.

To conclude, it would be advisable not agree or disagree with your employer on the final terms of your exit from the company . Ask for any proposed terms of termination to be put in writing to give you time to consider what is offered. If you are a higher rate taxpayer, try to make sure your termination package is paid after you receive your p45 as anything over 30,000 will be taxed at just 20% and you will have a further year to pay any tax owed. You may also wish to consider asking for part of your termination payment to be paid directly into your pension as this is treated separately from the 30,000 exemption.

Graham Cardona, a qualified solicitor with over 10 years experience, specialises in helping employees with advice and help on negotiating severance packages. If you need help or are looking for more information on redundancy compromise agreement, compromise agreement tax or on compromise agreements generally, simply click on the above links.

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Article Citation
MLA Style Citation:
Cardona, Graham "Will You Be Liable To Tax On The Severance Package Contained In Compromise Agreements?." Will You Be Liable To Tax On The Severance Package Contained In Compromise Agreements?. 26 Aug. 2010. 19 Aug 2014 <>.

APA Style Citation:
Cardona, G (2010, August 26). Will You Be Liable To Tax On The Severance Package Contained In Compromise Agreements?. Retrieved August 19, 2014, from

Chicago Style Citation:
Cardona, Graham "Will You Be Liable To Tax On The Severance Package Contained In Compromise Agreements?"

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