The payments under a Settlement Agreement will usually be split into contractual and non-contractual elements for example; outstanding holiday pay or bonus is a taxable payment and will be subject to normal deductions of tax and national insurance. These payments come within the Income Tax (Earnings and Pensions) Act 2003, Section 62.

Section 401 of the Act provides an exemption of up to £30,000 in respect of payments which are not chargeable to income tax but are received upon the termination of employment.  These payments may include a statutory, contractual or ex-gratia redundancy payment in a genuine redundancy situation, and non-contractual ex-gratia payments for loss of office or employment.  These may also include a non-contractual payment in lieu of notice.  However, if any Employer has a history of making non contractual payments which the Employee would reasonably expect to receive, these may be considered by the Inland Revue to be taxable earnings.  For example where the Employer makes a non contractual payment of notice but nevertheless makes a deduction in respect of tax and national insurance.

This is a difficult, complex and changing area of law that requires specific advice.