Settlement Agreement


Tax on settlement agreements can be calculated by using a (slightly complicated!) formula:

BP = basic pay in the last pay period to end before the termination date
D = the length of notice period
P = number of days in last pay period
T= the amount of any payment or benefit received in connection with the termination which:
• is not already subject to tax under another section of legislation,
• is not paid in respect of holiday pay,
• is not a bonus payable for termination of employment.

In short, employers are required to tax as earnings the part of a termination payment that is equivalent to the earnings the individual would have received had their notice period been worked in full.

Prior to April 2018 employers very often offered ‘compensation’ for not giving notice and as compensation, this amount would be tax free.

However, the government reviewed this and made changes to ensure all termination payments attract tax and National Insurance contributions.

Settlement agreements need to clearly set out how the amounts have been determined and this will in turn, determine the tax treatment of those payments.

Payment in lieu of notice and notice pay generally must be subject to usual deductions.

For advice on settlement agreements, whether you are an employer or employee, email from Beswicks or phone 01782 205000.