Repayment Clauses in Compromise Agreements

Thanks to Neil Russell of B.D. Laddie, who is the leading authority on this issue, for keeping me informed of his communications with the Inland Revenue

On 23rd May 2003, I sent out a bulletin concerning a disturbing new approach from the Inland Revenue, who were taking the view that where a compromise agreement contains a clause stating the monies are repayable in full if litigation is started in the future, the payment is brought within ICTA 1988, s313 (taxation of payments for undertakings restricting conduct) or, now, ITEPA 2003, s225.

This meant the Revenue were claiming tax on the full payment, rather than just that in excess of £30,000. [The bulletin of 23rd May 2003 is reproduced below]

This has become a significant issue amongst employment lawyers over the last few months. In the absence of formal guidance, different offices in the Inland Revenue have been taking different approaches.

The Revenue has now clarified its formal position on repayment clauses. Formal guidance will appear in the Tax Bulletin in October 2003 (and may appear on its website as early as next week).

The Revenue's official position is:

• it recognises that all compromise agreements contain an implied undertaking not to issue proceedings against the employer;
• it makes no difference if that undertaking is set out expressly as part of a repayment clause provided the sum of money payable under the compromise agreement is a real attempt to compromise the substantive claims;
• thus no tax is chargeable on any aspect of the monies paid under a compromise agreement, even where that money is repayable if the employee breaches an undertaking not to commence litigation;
• however, if the settlement sum is clearly in excess of a reasonable amount for the claims, the Revenue might regard the settlement as a 'sham' and investigate further.

In summary, provided the settlement sum is reasonable, there will be no tax chargeable on the first £30,000 of the termination payment even if a repayment clause exists in the agreement.

If anybody would like further information on this point, I suggest they contact Neil Russell of B.D. Laddie at n.russell@bladdie.co.uk.