Compromise agreements and the £30K tax exemption
In a recent case the tax tribunal decided that the £30,000 exemption applied to a payment made to a taxpayer by his former employer, after his contract had been terminated. HMRC had been arguing the payment was part of his normal taxable earnings.
The taxpayer earned almost £50,000 of his£60,000 salary in 2004-05 before his employment was terminated. Under the terms of a compromise agreement dated 23 December 2004, his former employer made a payment to him of £37,424.49. The payment was expressed to be in full and final settlement of all claims the taxpayer might have against his former employer. The payment was made net of basic rate tax and National Insurance contributions (NICs).
In his self-assessment return for 2004–05 the taxpayer claimed the first £30,000 of the payment was exempt from tax and sought a refund of the tax deducted by his employer.
In a letter dated 9 October 2008 the FD of the ex-employer described the payment as being in respect of commission due to the taxpayer. Such commissions were only payable as part of a discretionary bonus system that could not have resulted in a payment above £12,000.
The Tribunal noted that HMRC have generally accepted that payments made pursuant to a Compromise Agreement would not give rise to a tax charge where the employee enters into a restrictive covenant, as is typically case. Thus the £30,000 exemption should be available unless the payment is excessive or otherwise exceptional.
The Tribunal was unimpressed by correspondence from 2008 as it was written so long after the event by someone not fully involved in the negotiations 4 years earlier. The Tribunal also noted that the fact the employer had fulfilled their obligation to deduct tax at source was irrelevant.
The Tribunal thus determined that the £30,000 exemption was available in this case.