The tax-free status of payments of up to £30,000 paid to an employee as part of a settlement agreement has long been a useful element in negotiating a mutually acceptable and (relatively) affordable ‘parting of the ways’ between an employer and employee. Typically under a settlement agreement employment terminates immediately and there is no requirement for the employee to work his or her notice period. The employer and employee, having acknowledged that the employment has come to an end, can then move on having made a ‘clean break’.
In the (very) old days this payment could, in most cases, be made tax-free regardless of the employee’s contractual notice period and whether the employer had a contractual right to make a payment in lieu of notice (a PILON). EMI Group Electronics v Caldicott put an end to this in 1999. The employment contract contained a provision for a PILON. It was found that the element of the compensation payment that equated to the amount due to the employee as a PILON was an emolument arising out of employment and therefore taxable. As a consequence, many organisations had their contracts of employment re-drafted to remove the right for them to make a payment in lieu of notice.
From 6th April 2018, amounts within a settlement agreement that can be attributed to contractual amounts the employee would otherwise have been entitled to, in particular pay for his or her notice period, will be subject to Tax and NI. This is regardless of whether there is a PILON clause within the employment contract or not. This will result in added costs (essentially to the employer) and make an agreement more difficult to reach. For many ‘common sense’ reasons there is something intuitively wrong with this development. However, since there is now no longer a benefit in not having a PILON clause in an employment contract it is worth considering re-introducing one as it may afford a degree of protection against one particular ground for a constructive dismissal claim.