What Do New Anti–Avoidance Tax Laws Mean For Settlement Agreements?
On 6 April 2018, new anti–avoidance tax laws were introduced under the Finance Act 2017 which specifically targeted Settlement Agreements. This ended a tax loophole where employers could pay employees employees their gross notice pay, if their contract of employment did not include a payment in lieu of notice (PILON) clause.
This enabled employers to offer more compensation on termination of their employee’s contract, with no additional cost to them. However, by paying what would have been the tax and National Insurance to the employee, the treasury lost out on this revenue.
Compensatory sums in Settlement Agreements falling foul of tax evasion legislation
Surprisingly, we are still seeing employees being offered Settlement Agreements where their notice period is not being taxed.
Settlement Agreements must now be drafted so it is clear that the correct notice period has either been worked, or is paid in lieu, subject to the correct deductions for tax and NI.
Unless there has already been formal notice of termination, the start of any notice period under a Settlement Agreement cannot be retrospective.
This means that employers who want to offer Settlement Agreements to their employees should factor in the fact that tax and National Insurance must always be paid on their notice period and this can’t be included in an overall tax free compensatory sum.
Even in cases where an employee is dismissed for gross misconduct and a compensatory sum is negotiated some time later, perhaps when an Employment Tribunal claim has been issued, the subsequent loss of earnings during what would have been in the notice period needs to be paid as a taxable payment.
Similarly, where an employee resigns with immediate effect, without serving notice, to bring a claim of constructive unfair dismissal, any settlement reached or compensation awarded by an Employment Tribunal, must include taxable pay for what would have been the notice period.
So what does this mean for employers?
Any attempt to avoid paying tax on notice pay could result in criminal prosecution. Lawyers drafting and signing off these Agreements can also be prosecuted for assisting companies and employees in avoiding paying tax. As will employers or HR managers who knowingly assist in this type of tax avoidance arrangement. This means that Employment Solicitors cannot sign off Settlement Agreements where the tax on the notice payments has not been properly accounted for.
If you are currently planning on offering a Settlement Agreement to your employees, it is essential that you and your HR team understand these new tax provisions under the new Finance Act.