Taxation of Compromise Agreement Payments

Taxation of Compromise Agreement Payments: Everything You Need to Know

Compromise agreements are legally binding contracts that are entered into by an employer and employee when their employment relationship is terminated. These agreements are intended to resolve any outstanding disputes between the employer and employee, and usually involve a payment of compensation to the employee in exchange for them agreeing not to pursue any further legal action against their employer.

However, when it comes to the taxation of these payments, things can get a bit complicated. In this article, we’ll take a closer look at how compromise agreement payments are taxed and what you need to know.

Overview of Compromise Agreement Payments

Compromise agreement payments can be broken down into three main categories:

1. Payments in lieu of notice (PILON)

2. Statutory redundancy payments

3. Additional compensation payments

PILONs are payments made to employees who have been dismissed from their jobs without receiving the required notice period. This payment is usually made instead of the employee working their notice period, and is taxable as earnings under PAYE.

Statutory redundancy payments are payments made to employees who are being made redundant. These payments are generally not taxable up to a limit of £30,000, but any amount above this will be subject to income tax and national insurance contributions.

Additional compensation payments are payments made to employees as part of their compromise agreement, above and beyond any statutory redundancy or PILON payments. These payments can include compensation for loss of office, injury to feelings, or any other losses suffered by the employee as a result of the termination of their employment. Any additional compensation payments above the £30,000 tax-free limit will be subject to income tax and national insurance contributions.

How are Compromise Agreement Payments Taxed?

The taxation of compromise agreement payments will depend on the type of payment being made. As stated earlier, PILONs and additional compensation payments will be subject to income tax and national insurance contributions, while statutory redundancy payments are generally tax-free up to the limit of £30,000.

However, it’s worth noting that some employers may attempt to structure their payments in a certain way in order to reduce their tax liability. For example, an employer may attempt to label a PILON payment as a “non-taxable gift,” or they may attempt to pay an additional compensation payment through a tax-free trust. These types of arrangements can be complex and may require legal advice to fully understand the tax implications.

It is also important to remember that any compromise agreement payment made to an employee will need to be reported to HM Revenue and Customs (HMRC) using a P45 or P60 form. Failure to do so can result in penalties and interest charges.


Compromise agreement payments can be a valuable form of compensation for employees who are leaving their jobs under less than ideal circumstances. However, it’s important to understand how these payments are taxed and reported to HMRC in order to avoid any potential pitfalls. If you’re unsure about the taxation of your compromise agreement payment, it’s always a good idea to seek professional advice.

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