Why is there usually a Tax Indemnity in a Settlement Agreement?

Roger Cheves, a Specialist Settlement Agreement Solicitor, looks at why most Settlement Agreements contain a Tax Indemnity clause

The first £30,000 of an employment termination payment is usually exempt from tax, but any excess will be subject to income tax in the normal way. Any statutory redundancy payment or ex gratia payment will also probably be tax free.

The tax treatment of pay in lieu of notice (“PILON”) will depend on whether it is a right conferred by the employment contract, either expressly or impliedly. If so, it will be taxable as “earnings” in the normal way. However if there is no contractual right to the PILON then it should be exempt from tax, provided that the total termination payment does not exceed £30,000. Any payments which are allocated to restrictive covenants or confidentiality obligations will be taxable in full.

A Settlement Agreement will usually include a ‘tax indemnity’ clause. This provides that if additional tax is payable, it will be the liability of the employee rather than the employer. Neither the employer nor the employee can make guarantees about the tax status of any payments and Her Majesties Revenue and Customs (“HMRC”) reserves the right to look into any transactions and to decide whether or not tax should be applied. If HMRC do decide to tax, the employer is liable to pay the tax, which is why the indemnity clause is included in most Settlement Agreements. When such a clause is included it is helpful to the employee for there to be an additional clause in the Settlement Agreement to allow the employee (at his own expense) to raise objections with HMRC before a payment is made by the employer.

Roger Cheves is happy to answer any queries you may have in relation to Settlement Agreements without charge or obligation – You can email him at roger.cheves@sleeblackwell.co.uk