Settlement agreements

payments).

Settlement agreements

What tax rate should be used when deducting

tax?
PAYE74015 explains the different rules when
deducting tax.

(see also Tax and termination payments)

Employment may be terminated by mutual
agreement, as may tribunal proceedings. Tribunal
claims may be settled through early conciliation
through ACAS, after the proceedings have begun
through a COT3 by ACAS, by agreement between
the parties or in the form of a tribunal order
dismissing the proceedings upon agreement
having been reached between the parties.
Agreement between the parties may be reached
by a number of routes both informal and formal
including mediation, with some cases being
mediated by tribunal judges under the official
judicial mediation schemes.

Termination payment made on or before date of

P45
If the termination payment is paid on or before
the P45 is issued, tax and NI will be deducted
from any taxable termination payment through
the normal payroll using the employees tax code
at that date.
Termination payment made after the date of P45
Prior to 6 April 2011, any taxable termination
payment made after the P45 was issued was
taxed by the employer at the basic rate. For
employees who paid tax at a higher rate this
regime gave them a cash flow advantage in that
any further tax to be paid via their selfassessment would not be due for several months.
This changed from 6 April 2011 such that any
taxable termination payments made after the P45
was issued should have tax deducted using the
tax code 0T (effectively ignoring any personal tax
allowance) and on a non-cumulative basis (which
treats each pay period as a separate tax period).
This can mean that the employee pays too much
tax initially and would have to claim it back from
HMRC on their self-assessment.

Formalities
Where the agreement between the parties is
reached other than by use of a COT3 form, any
agreement by an individual that they will not
bring any of a number of employment rights will
be ineffective unless certain formalities have
been undertaken (see for example s203 ERA 1996
and s144 and 147 EA 2010). For the compromise
of a claim to be valid:
The contract must be in writing
The contract must relate to a particular
complaint

Sometimes payments paid in instalments may

benefit the cash flow for both parties. Each
tranche of the termination payment will be
taxable independently on the above 0T basis, on
the date of entitlement.

The individual must, before entering into the

contract, have received advice from an
independent legal advisor about its terms and
effect
On the date of giving the advice there must
have been in force insurance or an indemnity
against losses arising from giving the advice

For monthly paid employees (using 2013/2014

tax bands)
Only the first 2,667 (i.e. 1/12 x 32,010) of the
settlement payment will be charged at basic rate
of 20%;

The contract must identify the advisor

The contract must state that bullet points 3
and 4 above have been complied with.

The next 9,832 (i.e. 1/12 x 117,990 (150,000 32,010) will be charged to tax at the higher rate
of 40%; and

Contractual entitlements
Where a settlement agreement makes payment
for contractual payments that have already
crystallised, it may well be that such sums would
be taxable as earnings rather than under s401
ITEPA 2003 (see EIM12856).

Any remaining balance of the termination

payment will be taxed at 45%.
Example
A termination payment of 75,000 is paid to an
employee on 01/05/2013 after his P45 has been
issued. 55,000 of this payment is taxable. He will
pay:

Legal expenses
The employer may agree to pay legal costs
incurred by the employee. Such a payment may
be within s401 ITEPA 2003 since it is made in
connection with the termination (see EIM13010)
but may not be charged (see Tax and termination

20% of 2,667 = 533.40, plus

40% of 9,832 = 3,932.80, plus

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Sex Equality Clause

45% of (55,000 2,667 9,832) = 45% of

42,501 = 19,125.45

arrears of pay may be claimed (see s132(4)). In

the standard case arrears over the preceding 6
years may be awarded, but where the breach of
the clause has been concealed or the individual
had an incapacity at the date of the breach, and
the claim was presented within 6 years of the
date the claimant knew of the claim or was
capable of bringing the claim, arrears may be
claimed from the date the arrears first occurred
(s132(3) EA 2010).

So his total tax liability, which is payable

immediately by the employer, is 23,591.65.
If the employee had received his payment prior to
6 April 2011, his immediate tax liability would
have been 20% of 55,000 = 11,000.

Sex discrimination: see

Discrimination

Gross or net: Gross (but then taxed by the

employer in the normal way through the payroll).
Limit on a week's pay: None

Sex Equality Clause

Limit on number of years: Normally 6.

Adjustments: Interest can be awarded for arrears
of pay and will be calculated according to the
mid-point rule (see Interest).

A sex equality clause is implied into every

contract of employment, if one is not already
present (s66 EA 2010). The effect of a sex equality
clause is that any term of an individuals contract
of employment, if it is less favourable to him or
her than the same term is to a comparable
employee of the opposite sex, will be modified so
as to not be less favourable. A comparable
employee will be of the opposite sex, and the
work they are employed to do will be equal (s64
and 65 EA 2010).

Any maximum or minimum: None

Tax: Awards (or settlements) in respect of claims
under the Equal Pay Act 1970 (now EA 2010 Part
V, Ch 3) are arrears of pay and therefore should
be taxed under s62 ITEPA 2003 (see EIM02530
HMRC). The tax liability arises in the year of
entitlement not in the year of eventual payment.
It is unclear whether any interest would also be
taxed.

This applies to all the parts of the contract

including:

Statutory authorities: EA 2010 ss66 and 132; The

Employment Tribunals (Interest on Awards in
Discrimination Cases) Regulations 1996)

wages and salaries;

non-discretionary bonuses;
holiday pay;

Share options: see Benefits

sick pay;

Short time working: see Guarantee

payment; Week's pay

overtime;
shift payments;
occupational pension benefits; and

Sickness: see Holiday pay

non-monetary terms such as holiday or

other leave entitlements or access to sports
and social benefits.

Simplified approach: see Pension

loss

An employee may bring a claim to the tribunal for

breach of his/her sex equality clause under s132
EA 2010.

Social security benefits: see

Income support; Job seekers
allowance; Non-recoupable state
benefits; Recoupment

Remedy: If a tribunal finds that there has been a

breach of the sex equality clause it may make a
declaration as to the rights of the parties (for
example, stating what pay or rate of pay the
individual is entitled to). The tribunal may also
order an award of arrears of pay or damages
(s132 EA 2010).
A limit is imposed on the period over which
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