Compromise agreements, also known as settlement agreements, are legally binding contracts between an employer and employee that detail the terms of ending an employment relationship. In general, these agreements offer a way for both parties to come to a mutual agreement and avoid costly and time-consuming legal battles.
One of the benefits of compromise agreements is that they may be tax-free up to a certain amount. This allows employers to provide some level of compensation to outgoing employees without the added burden of additional taxes. However, there are specific rules and guidelines that must be followed in order for the compensation to be considered tax-free.
According to HM Revenue and Customs (HMRC), payments made to employees in relation to the termination of their employment may be eligible for tax exemption up to £30,000. This includes any payments made as a result of a compromise agreement.
To qualify for tax-free status, the payments must be made in respect of the employee’s employment and must not relate to any non-employment services or activities. Additionally, the payments must not be part of the employee’s normal earnings or contractual entitlements.
It is also important to note that payments made in lieu of notice (PILON) will usually be subject to income tax and National Insurance contributions, regardless of whether they are made under a compromise agreement. This is because PILON is considered a taxable part of the employee’s earnings.
In order to ensure that both parties are protected and that the tax implications are properly addressed, it is recommended that a qualified legal or tax professional be consulted when creating and finalizing a compromise agreement.
In summary, compromise agreements can offer a tax-efficient way to reach a mutually beneficial agreement between employers and employees. By following the proper guidelines and consulting with qualified professionals, both parties can benefit from a smooth and efficient termination of employment.