Chris Hadrill, a specialist employment solicitor at Redmans, answers the question:

“What sums paid to me under my settlement agreement should be free of tax?”

Given that the question is one which is general in nature, it is not possible to provide a specific answer – which sums will be taxed and which sums will not be taxed will vary in each circumstance depending on the particular facts. However, it is possible to provide some general guidelines as to when employees may expect sums to be taxed and when they may expect them to be untaxed – we will examined this as follows:

  1. Which payments under a settlement agreement will generally be taxed?
  2. Which payments under a settlement agreement will generally be free of tax?

Which payments under a settlement agreement will generally be taxed?

‘General earnings’ will normally be subject to tax (and, where applicable, national earnings) under a settlement agreement. General earnings will normally (but not always) include (but are not limited to) the following types of payment:

  • Any salary, wage or fee (salary, bonus, commission etc.)
  • Any other kind of benefit (health insurance, life assurance, car allowance etc.)
  • Anything that constitutes a ‘contractual emolument’ of employment
  • Employer-financed retirement benefits
  • Payments and benefits upon termination of employment (which payments will be deemed to be related to termination will depend on the circumstances)
  • Income from securities
  • Gardening leave payments
  • Consideration for restrictive covenants
  • Contractual payments in lieu of notice

Which payments under a settlement agreement will generally be free of tax?

The first £30,000 of payments that fall within section 401 ITEPA 2003 are generally exempt from tax. Any excess above £30,000 will be subject to tax in the normal way. The following non-contractual payments are generally tax-free:

  • Ex-gratia payments
  • Damages for wrongful dismissal and payment on account of damages
  • Compensation for unfair dismissal or other breach of statutory rights
  • Compensation for injury to feelings and/or personal injury in discrimination cases (although this depends upon whether the discrimination was pre-termination or in connection with termination)

If you have been offered a settlement agreement by your employer (or are an employer offering a settlement agreement to an employee) and you are unsure as to which sums under your settlement agreement should be taxed (and which sums should be free of tax) then it is recommended that you obtain legal advice on your position – this is a reasonably complex area of law and getting it wrong can have potentially serious consequences. However, you may also follow the guidance provided by HMRC on determining the correct tax treatment of a termination payment – HMRC recommends that the following questions are addressed:

  1. Does the payment fall within the category of general earnings (or is it a benefit of the employment) under Parts 2 to 5 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA 2003”)?
  2. If not, is it a payment for a restrictive covenant taxable under sections 225 and 226 of ITEPA 2003?
  3. If not, and no other income tax charge applies (for example, compensation for loss of a share option) ,is the payment a payment taxable under sections 401 to 416 ITEPA 2003?



Redmans Employment Team deal with employment matters for both employers and employees, including drafting employment contracts and policies, advising employers and employees on compromise agreements, handling day-to-day HR issues, advising on restructures, and handling Employment Tribunal cases for both employers and employees

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Patient and thorough advice given to me around my Settlement Agreement

Posted 11 hours ago


"Excellent service, getting back to you promptly giving you very good advice."

Posted 1 day ago


I found Chris Hadrill to be an excellent help, he is very knowledgeable and gives good ,concise ,strategic advice .He makes himself readily accessible when you need him.I would personally highly recommend him.

Posted 3 days ago


Professional, efficient and reliable service provided. I strongly recommend them and I would use this service again.

Posted 3 days ago

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