In a dispute over whether tax was payable on a very large settlement sum, the High Court has determined (no doubt, to the huge relief of the employer) that the proper construction of a clause "to pay £1,350,000" was that the sum was to be paid net of tax (that is, after deduction of income tax). The clause did not say that tax was deductible. The parties agreed that:
- The settlement sum was subject to income tax as employment income. It represented a bonus .
- The former employer, was liable to account for this tax under PAYE.
The court rejected the claimant`s construction that £1,350,000 should be paid gross (that is, without deduction) as a "commercial absurdity". (The employer must "gross up" a gross payment by reference to the taxpayer`s marginal tax rate and account to HMRC for tax on the grossed-up amount. Here, the resulting total would have been £2,700,000, with HMRC and the claimant each receiving £1,350,000.)
Given the court`s construction, rectification was not necessary. However, the court confirmed that, had it construed the clause to require a gross payment, it would have ordered rectification on the grounds of common mistake.
Clearly, settlement agreements should always spell out very clearly that the sum to be paid is subject to tax and National Insurance. Especially, when £1.35 million is at stake!