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By Fiona E Martin

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Compromise Agreements are legally binding agreements between an employer and an employee, sometimes referred to as a termination settlement. They allow for a clean break of the employment relationship where the employee waives their right to bring claims in return for compensation.

The first £30,000 of compensation is generally tax free. However, this is not the case with every Compromise Agreement. How much of a payment is taxable depends on the basis on which it is paid. So if you are giving or receiving compensation in a Compromise Agreement it pays to look at ways to make it as tax efficient as possible. Here are some of the options.

Salary and benefits to date
All payments made up to the point the contract of employment ends are subject to normal tax and national insurance deductions.

Payment in lieu of holiday
Payments in lieu of holiday are taxable.

Pay in lieu of notice
Where such payments are allowed for in the employee's contract of employment or employee handbook they are taxable. Where they are not, they may be paid gross and count towards the £30,000 exemption.

However, where an employer routinely makes payments in lieu of notice - even if it is not part of the employment contract - HM Revenue & Customs may consider tax should be deducted.

Payments for restrictive covenants and confidentiality obligations
An employer may restrict an employee from acting in competition, or approaching customers or employees after they leave. If the contract contains enforceable restrictive covenants, the employer can rely on these if it has not breached the contract when terminating the employment.

However, if the contract does not have these provisions, or they are unenforceable, the employer can seek new restrictions. To make these binding in law a "consideration" must be paid - usually a small sum of £100-£200. This is taxable and liable to national insurance contributions. The same applies to payments associated with a confidentiality clause.

Compensatory and ex-gratia payments
The first £30,000 of compensatory, ex gratia (non-contractual) payments for loss of office or employment is tax exempt.

Redundancy Compromise Agreement
Statutory and contractual redundancy payments fall within the £30,000 exemption.

Pension contributions
Direct payments into a pension scheme are not taxable unless they exceed annual and lifetime contribution allowances.

Outplacement costs
Contributions to the cost of outplacement counselling or training are not taxable. Usually paid directly by the employer, they do not count towards the £30,000 exemption.

Legal costs
The employer usually pays the employee's legal costs. This does not count towards the £30,000 exemption as long as the fees are solely in connection with termination of employment.

Sums exceeding the £30,000 exemption
If the Compromise Agreement compensation exceeds the £30,000 exemption, tax is deducted at basic rate on the additional amount.

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