Taxation of payments for restrictive covenants

By Tolley in association with Sue El Hachmi of Osborne Clarke LLP
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The following Employment Tax guidance note by Tolley in association with Sue El Hachmi of Osborne Clarke LLP provides comprehensive and up to date tax information covering:

  • Taxation of payments for restrictive covenants
  • Restrictive covenants
  • Tax treatment
  • Restrictive undertakings in termination agreements
  • Repayment clauses
  • Excessive sums

Restrictive covenants

These are undertakings given by employees during employment or on termination which restrict their conduct or activities. Due to historic debate as to whether such payment fell within the general earnings of the relevant income tax acts, there is a specific charging provision which ensures that payments made in connection with current, future or past employments or offices are taxable as earnings.

Tax treatment

ITEPA 2003, s 225 taxes payments made to an individual for entering into restrictive covenants. In order for consideration to be brought into charge by ITEPA 2003, s 225, the following conditions must be satisfied by the individual:

  • a restrictive undertaking is given in connection with a current, future or past office or employment
  • the undertaking must restrict conduct or activities. It may be absolute or qualified and need not be legally binding.
  • a payment is made in respect of the giving of the undertaking or its partial or total fulfilment. It does not matter to whom the payment is made.
  • the sum would not otherwise be treated as general earnings
  • any earnings from the same employment would be taxable in the UK because the individual

More on Termination of employment: