Settlement (compromise) agreements

Produced by Tolley in association with Sue El Hachmi of Osborne Clarke LLP

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

  • Settlement (compromise) agreements
  • Identifying the component parts of the agreement
  • Compensation payments
  • The Gourley principle
  • Particular areas to note in the context of settlement agreements
  • Restrictive covenants and repayment clauses
  • Repayment clauses
  • Legal fees
  • Payment after termination
  • Tax indemnities

Settlement (compromise) agreements

An agreement can be entered into by the employee and employer to end the employment on the terms set out within the agreement called a settlement agreement (known as a compromise agreement until 29 July 2013). This has specific legal meaning, in particular, applying where an employee has potential claims against the employer under the Employment Rights Act 1996 or other employment legislation, or where the employee would otherwise have a claim for breach of contract. Key managers and shareholders may sign settlement agreements if they leave employment when the employing company is sold.

The main reason for entering into a settlement agreement is that the employer has certainty that the employee will have no claim in the future against the employer.

Among other things, the settlement agreement will set out all payments and benefits due to the employee from the employer. This guidance note addresses the employment tax implications of a settlement agreement. Legal advice should be taken on all other aspects of the agreement. See Simon’s Taxes E4.823.

Whilst the settlement agreement is signed on termination, not all payments and benefits within it will necessarily fall within the main set of provisions dealing with payments and benefits on termination. The considerations on taxing the various elements of an agreement are discussed in the Termination payments ― overview and How could a termination payment be taxed? guidance notes. In practice, most settlement agreements will include some element of compensation and it is this element which often requires the most analysis. HMRC guidance is at EIM12855.

Identifying the component parts of the agreement

As with all termination payments, the tax treatment will follow the component parts. A settlement agreement will either set out all payments and benefits individually or have one global compensatory sum. In both cases, the employer should keep records of the discussions about, and the basis of, each payment to enable the employer to justify and defend any challenge. If a global sum

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