EIM03606 - Restrictive covenants: compromise agreements

Section 225 ITEPA 2003 and Statement of Practice 3/96

When an employment is terminated the employee may enter into an agreement with the former employer to accept a payment "in full and final settlement" of all of the outstanding claims against the employer. In doing this, the employee accepts that the sum payable satisfies claims and legal rights that arise either under the terms of the employment or statutory provisions. The employee therefore gives up his or her rights to pursue claims before an Employment Tribunal or in the courts. Agreements of this kind find their origins in The Trade Union Reform and Employment Rights Act (1993). This legislation refers to "compromise contracts or agreements" which bind both parties to the agreement.

By agreeing not to pursue claims before a Tribunal or Court, the employee is giving an undertaking that restricts conduct. It follows that any sum given in respect of that undertaking falls within Sections 225 to 226 ITEPA 2003 (see EIM03601). Such a sum is not within the terms of Statement of Practice 3/1996 (see EIM03610) because the parties themselves are attributing a value to the undertaking. So where the agreement attributes a specific sum to this undertaking it is taxable.

Such an attribution is not very common. Usually, no specific sum is attributed to this undertaking in the agreement so there is no charge in respect of it.

Compromise agreements often contain a "repayment clause". Such a clause provides that if the employee does later initiate proceedings before a Tribunal or Court - despite signing the agreement - then the sum paid under the agreement must be repaid to the employer. In a normal case, do not argue that such a clause means that a sum is being attributed to the undertaking not to pursue claims. In virtually all cases, the sum paid under the agreement can be fully attributed to settlement of the claims being dealt with. So there is no sum remaining to be attributed to that undertaking, even where there is a repayment clause.

If the employee does repay such sums, there is no provision in the legislation that gives any deduction for that payment.

In some exceptional cases it may appear that the sum paid under the agreement is excessive in the context of the claims being settled. Where that is the case it may be that part of it should be attributed to the undertaking not to pursue claims, even though there is no specific attribution in the agreement. (This text has been withheld because of exemptions in the Freedom of Information Act 2000)