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Compromise Agreements - Are You Paying Too Much Tax?

A compromise agreement is an agreement between an employee and an employer, setting out the terms on which the employee will agree not to pursue a claim against the employer.

The law states that individuals cannot generally contract out of their employment rights. There are however a few exceptions to this rule. One of those exceptions is where a settlement is reached by way of a compromise agreement.

It is essential that employees fully understand their employment rights before contracting out of them. This is why the law requires employees to obtain legal advice from a qualified legal adviser, such as a solicitor.

If you have been offered a Compromise Agreement to terminate your employment, you must ensure that your solicitor understands not just your employment rights but also how any payments you receive will be taxed.

The basic position is that compensation for loss of employment is not taxable up to a maximum of 30,000.00. This includes any redundancy payment.

Any payments due under an employment contract are taxable. This will include salary up to the date of termination, payment for accrued but untaken holiday as well as bonus and commission payments.

But what happens when the Compromise Agreement provides that the employee will receive a sum of money instead of working a notice period? This is known as a Payment in Lieu of Notice ("PILON").

If the employee works the notice period, the salary is taxed in the normal way. Unfortunately, the position is less clear with a PILON. Is it taxable as a payment under the employment contract or is it a tax free compensation payment for loss of employment?

The issue is determined by whether or not there is a clause in the employment contract allowing the employer to make such a payment, known as a PILON clause.

If there is no PILON clause in the employment contract, the position is straightforward. Any PILON in the Compromise Agreement is not classed as a payment under the employment contract. The employer is deemed to be breaking the employment contract by not allowing the employee to work his notice. The payment is classed as compensation for breach of the employment contract and can be paid tax free up to 30,000.00.

The position is different if the employment contract does contain a clause allowing the employer to make a PILON. If an employer has a discretionary right to make a PILON and chooses to do so, the payment will be subject to tax. It is deemed to be a payment made under the employment contract.

If however the employment contract gives the employer the discretion to make a PILON but the employer chooses not to do so and pays compensation instead, it may still be deemed to be taxable as a PILON. This is more likely when the "compensation payment" is substantially the same value as a PILON would have been.

Compromise Agreements often state unnecessarily that tax will be deducted from the PILON. When you choose a solicitor to advise on your Compromise Agreement, you must ensure that they are fully familiar with the way that termination payments will be treated for tax. It may be that, with a bit of re-wording, you could save thousands of pounds!

Andrew Crisp is a solicitor at Advantage Employment Law and regularly advises employees on Compromise Agreements. Further details can be found at www.compromiseagreement.org.uk.

Source: www.articletrader.com