Taxation of termination payments—settlement agreements
Produced in partnership with Sue El Hachmi, Tracey Wright of Osborne Clarke and Sam Whitaker of Shearman & Sterling LLP
Taxation of termination payments—settlement agreements

The following Tax guidance note Produced in partnership with Sue El Hachmi, Tracey Wright of Osborne Clarke and Sam Whitaker of Shearman & Sterling LLP provides comprehensive and up to date legal information covering:

  • Taxation of termination payments—settlement agreements
  • Identifying the component parts of the settlement agreement
  • Compensation payments—risk of challenge on tax status
  • Restrictive covenants
  • Repayment clauses
  • Legal fees
  • Payments after termination
  • Payments for loss of future pension rights
  • Tax indemnities

Where an employee has potential claims against the employer under the Employment Rights Act 1996 (ERA 1996) or other employment legislation, or where the employee would otherwise have a claim for breach of contract, a settlement agreement (formerly known as a compromise agreement) can be entered into by the employee and employer to end the employment on the terms set out in that agreement (though there are a few instances under employment law when claims cannot be ended with a settlement agreement). Key managers/shareholders may also sign settlement agreements if they leave employment when the employing company is sold.

For a precedent settlement agreement (and drafting notes), see Precedents: Settlement agreement (employment) or Settlement agreement (employment) (short form).

By entering into a settlement agreement, the employer has certainty that the employee will have no claim in the future against the employer.

Among other things, the settlement agreement will deal with all payments and benefits owing or agreed to be paid to the employee.

While the settlement agreement is signed on termination, not all payments and benefits within it will necessarily fall within Chapter 3, Part 6 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) which is a specific set of provisions dealing with payments and benefits on termination. For more information on the UK tax treatment of termination payments, see Practice Notes: