Settlement agreements and Protected Conversations

Posted on: February 9th, 2016

Settlement agreements can be tricky to negotiate, but they are a very useful tool when you want to manage the exit of a difficult employee. We recommend that you follow these tips:

  • If there is no existing dispute, have a ‘protected conversation’ first. You can have a Protected Conversation with an employee to set out your concerns (e.g their poor performance) and explain that you hope to agree an amicable exit from the organisation without having to go through a formal process. Provided that you do not use any “improper behaviour” a Protected Conversation will be off the record and so the employee cannot rely on the conversation as evidence in an Employment Tribunal. If the employee isn’t interested in a settlement agreement then you want to be sure that they can’t use this discussion against you;
  • If there is an existing dispute, make it clear that you are having a ‘without prejudice’ conversation so that your conversation cannot be used against you if the employee doesn’t go on to sign the settlement agreement;
  • Be clear about the terms of the offer you are making and the reason you’re making the offer;
  • Consider the tax implications of your offer – will any of the sums be subject to tax and NI?
  • Give the employee an offer letter stating the main terms, and a draft settlement agreement to consider;
  • Do not say or otherwise imply that the employee will definitely be dismissed (e.g. for performance, redundancy etc) if they don’t accept the settlement agreement;
  • Do give the employee sufficient time to consider the offer;
  • Do consider allowing the employee paid time off while they are considering the offer;
  • It is a legal requirement that individuals obtain independent legal advice on the terms of a Settlement Agreement. Although it is not compulsory, employers are expected to make a contribution towards an employee’s legal fees in taking the necessary advice. The contribution will vary according to the circumstances of the case but is likely to be in the region of £200 – £500 plus VAT.

One of the benefits of using the settlement agreement route to manage the exit of an employee is that you can usually take advantage of the tax exemption which allows for a proportion of the termination payment to be paid tax and NI free. Unfortunately, proposed changes could make it considerably more expensive to agree exits with employees.

Current position

In simple terms, employers can make a payment of up to £30,000 tax free if it’s a genuine compensation payment for loss of their employment. This includes redundancy payments. This only applies to payments that are not chargeable to income tax already. So, if the payment is really a bonus or a payment in lieu of notice, for example, that would be taxable already, the payment will not benefit from £30,000 free of tax.

Generally, no national insurance contributions are payable on genuine termination payments either below or above the £30,000 cap.

Apart from issues regarding disguised payments, and questions over when notice pay can be tax free, most employers find this system fairly straightforward. The advantage to employers is that offers of compensation made under settlement agreements are much more attractive to employees due to the tax free element, making them more cost effective for employers.

However, the government thinks otherwise, and the (ironically named!) Office of Tax Simplification recently made proposals for change, which the Government has broadly followed.


At the moment the Government proposes to remove the current £30,000 allowance. Instead they’ll be an exception for redundancy payments only. Rather than a single set limit, the tax free allowance will be at a rate rising in line with length of service – so for example, an employee with 10 years’ service would be entitled to a higher tax free element than an employee with 5 years’. Under the current proposals the exemption would also only apply to employees made redundant after two years of employment.

All notice payments and other compensation payments would be subject to tax and national insurance contributions in the usual way.

If the changes are implemented, this will have a significant impact on employers. Under the proposal it will be much more expensive to make payments under a settlement agreement, due to the tax and NI bill, and the fact that payments will need to be higher to make them attractive to employees.

We’re not sure how this can be said to amount to a simplification of the system. There’s likely to be debate about what amounts to a redundancy payment (does this include settlement agreements offered under a protected conversation before a redundancy consultation process has started, for example?) with employers trying to crow bar situations into redundancy to gain the tax free element.

It will also mean employers need to consider length of service in each case – which is not always simple, for example if employees have transferred into the organisation or had periods of time out.

The consultation closed in October, and we anticipate an announcement in the March statement and changes could take effect as early as April 2016.

If you have any concerns about handling settlement agreements, do please get in touch with Holly Cudbill, or why not join us on 25 February for our training workshop.

Settlement Agreements and Protected Conversations: dos and don’ts for managers
Thursday 25 February 2016 – half day training workshop

Coffin Mew’s Employment Team will be running a half-day training workshop on ‘Settlement Agreements and Protected Conversations: dos and don’ts for managers’ on Thursday 25 February. This interactive workshop, with case studies and the opportunity to share your own experiences with like-minded professionals, will give you the practical tools you need to tackle this increasingly important area. If you wish to book onto the training workshop, please click here.