What is meant by a tax indemnity in a settlement agreement?

It is common place for the settlement agreement to have a tax indemnity. This means that if HMRC decide that the termination or ex-gratia payment you were given by your employer as a tax free payment should have been taxed in full or in part then HMRC will contact your employer as this should have been deducted at source through PAYE.

The agreement then normally provides that if such a demand is made, you will indemnify your employer against that demand which basically means you will pay the tax demand if they are asked to pay HMRC tax on that payment. There are variations on the clause and some include any interest or penalty HMRC add onto the deduction that should have been made.

We would normally request that you first have the opportunity of disputing this payment before it is made and secondly that your employer gives you reasonable access to any documentation you may require. A tax indemnity clause can b e daunting but it is quite standard and you should be given some advice on the tax status of the payments although there are no guarantees, your solicitor should advise you if any payments ought to be taxed and separated out. This will give you an indication as to the level of risk. One of the key areas to be examined when you go through the terms is the tax treatment of the notice period as this can be an area where issues arise as well as holiday pay and bonuses. These tend to be the riskier areas.

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