Settlement Agreements are used in order to end an employment relationship on agreed terms. It is a legally binding document and can also be used to resolve ongoing workplace disputes. As a result of signing the agreement, the employee will be unable to make claims in the employment tribunal about any type of claim which is mentioned in the agreement. It can be a useful tool to use, on the back of instigating a “without prejudice” or “protected” conversation. It is not uncommon for Settlement Agreements to be proposed before the end of a financial year, it is therefore important for both employees and employers to understand the law on them and their application.
The Agreement can be proposed by either an employer or employee; however, it is usually the employer who makes the first approach. To be legally valid, a Settlement Agreement must:
- be in writing
- relate to a particular complaint or disciplinary proceedings
- only be signed after the employee has received independent legal advice from an identified advisor who holds the required professional indemnity insurance
- state that the conditions regulating Settlement Agreements under the relevant statutory provisions have been satisfied
Settlement agreements may include an ex-gratia payment, this is a sum of money that the employer agrees to pay over and above any entitlements under the contract of employment. An ex- gratia payment is highly tax efficient as it falls under a tax exemption from s.403 Income Tax (Earnings and Pensions) Act 2003 for any amounts under £30,000.00. This is because the payments made are not made for the work that has been undertaken or for a provision of services; they are a “voluntary” payment made by the employer.
However, this does not mean that all payments benefit from the tax exemption. The taxation of settlement agreement payments is a complex matter and since April 2018 notice pay has been taxable as general earnings and subject to Class 1 NICs. The post-employment notice pay is calculated by using a formula set out in the legislation to the total amount of the payment, or benefits paid in connection with the termination of an employment. Therefore such payments made in connection with the termination of employment will not benefit from the £30,000 threshold.
Care must be taken when drafting and negotiating Settlement Agreements as the taxation rules noted above prevent employers from trying to make severance payments more attractive to employees by deliberately leaving payment in lieu of notice clauses out of contracts of employment, so notice pay could be paid in a more tax friendly manner. Payment in lieu of notice without the proper tax being deducted can have significant ramifications for both the individual and the business.
Given that we are almost at the end of the current financial year, it is a more common time for employers to be offering their employee’s settlement agreements. If this is something that you intend to offer your employees, or if you have been offered one by your employer contact us, we can provide specialist advice.