What is an ex gratia payment?
‘Ex-gratia’ is Latin for ‘out of goodwill’ or ‘by favour’.
Ex-gratia payments are sometimes known as ‘golden handshakes’, ‘golden boots’ or ‘golden goodbyes’.
You might be offered an ex-gratia payment if:
- Your employer is found to have treated you badly
- You are leaving work after a dispute
- Your job has been made redundant
An ex-gratia payment is a gesture of goodwill because your employer isn’t legally obliged to provide it. There’s no limit to how much they can offer you, although your employer might feel constrained because they have to pay National Insurance on any termination payment over £30,000,
In return for accepting the money, you’ll be asked to sign a settlement agreement* confirming that you won’t take your employer to court later.
*Settlement agreements are known as compromise agreements in Northern Ireland.
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Ex-gratia payments and tax
The government funds courtrooms and pays for tribunal judges, so it’s in their interests to avoid such costs.
In order to save these expenses, and reduce the likelihood of claims going to court, the government introduced a tax break on ex-gratia payments meaning that the first £30,000 is free of tax and National Insurance.
When you do your tax return, you will have to tell HMRC that you’ve received an ex-gratia payment. Tell your accountant or tick the ‘ex-gratia’ box on the form.
You’ll have to pay tax and NI on your salary, notice, commissions or other benefits as usual while you’re working, as well as on any ex-gratia payment above £30,000 and on any compensation you receive.
To reduce tax if you’re being offered more than £30,000, we could negotiate for your employer to put some or all the excess towards your legal costs.
If ex-gratia payments are mentioned in your contract or are part of your employer’s established routine, there’s a risk that HMRC will see it as an entitlement rather than as a goodwill gesture.
To get round this, we could negotiate for the ex-gratia payment to be made direct to your pension fund. This idea works best if you’re nearing retirement age, because the money will be tied up and difficult to access.
Don’t panic if you see a tax indemnity clause in your settlement agreement, stating that you are “liable to account to HMRC and/or the employer for any unpaid tax”.
It’s a traditional clause which is there just in case the Chancellor ever changes the tax laws to make ex-gratia payments taxable. However, tax laws are never implemented retrospectively, so it’s exceedingly unlikely that the clause will be applied.
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Are you facing redundancy?
In a settlement agreement, any statutory redundancy pay and any lump sum can be made into an ex-gratia payment.
It’s likely that you and your employer will want the redundancy to proceed as quickly as possible.
- You might want to take the money and get on with finding a new job
- Your employer might want to avoid an extended period of consultation before your employment ends
This is why they may offer you an ex-gratia payment on top of any statutory redundancy pay you’re entitled to – it’s usually equivalent to one month’s pay.
You may still get a month’s worth of salary as a redundancy ex-gratia payment even if you have less than two years’ employment (meaning you don’t legally have any unfair dismissal rights and can’t complain if the redundancy process is unfair).
Note that contractual notice pay is taxable but the first £30,000 of redundancy pay is tax-free (including any ex-gratia element).
It is important to have these (and many other) details stated absolutely clearly in the written settlement agreement.
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About us: At Paul Doran Law, we specialise in employment law – this includes settlement and severance matters as well as claims about equal pay, discrimination, unfair or constructive dismissal, and unpaid wages or holiday pay.
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Making a discrimination claim?
On the subject of tax…
If you win a discrimination claim, you might be offered compensation for injury to feelings. If your case is especially serious, you might also be offered damages for psychiatric damage or personal injury.
There is a tax exclusion called the ‘Disability Exemption’ which applies if you receive compensation for impairments caused by an injury or a disability (this is distinct from compensation for injured feelings).
It means you may get total tax exemption for termination payments made because of your disability or injury where it prevents you from fulfilling your employment duties.
FAQs about ex-gratia payments
Here are some common questions about ex-gratia payments answered, at a glance.
Q. What is an ex-gratia payment?
A voluntary payment or gift paid to you by your employer.
Q. Why might I be offered an ex-gratia payment?
An ex-gratia payment is usually offered as compensation for loss of employment.
Q. Is my employer obliged to offer me an ex-gratia payment?
No, but it’s quite common, especially in the redundancy process when it’s called an enhanced redundancy payment.
Q. How do I know the payment I’m offered is an ex-gratia payment?
Look for these words: “protected conversation”, “pre-termination discussion”, “without prejudice”, “severance package”, “exit package”.
Q. Can I negotiate the amount of my ex-gratia payment?
Yes, and we can help you with that.
Q. Do I have to pay for receiving legal advice?
Your employer will usually cover the costs of our advice on a settlement agreement. If you want us to try and negotiate a better deal, there may be additional costs which can often be paid at the end.
Q. Is an ex-gratia payment taxable?
The first £30,000 is tax-free. Statutory redundancy payments are tax-free. Payments into your pension can be tax-efficient.
Q. Do I have to report my ex-gratia payment to HMRC?
Usually not. In most cases, if the payment is under £30,000, tax or national insurance (NI) will not be due. If it is above £30,000, tax and NI will usually be deducted by the employer before you receive the balance.
Q. What if I have a dispute with HMRC about whether my ex-gratia payment is tax-free?
If this happens, you should seek specialist tax advice to confirm your unique situation.
Q. If I get an ex-gratia payment as compensation for injury to feelings, is it tax free?
You might be awarded compensation for injury to feelings in a discrimination case. If the payment is tax-free depends on whether the discrimination and injury to feelings is related to the termination of your employment. If not, then it can be paid tax-free. If yes, anything about £30,000 could potentially be subject to tax.
Q. When do I have to pay tax and NI?
Even if you’re receiving these amounts as part of a settlement agreement, you’ll pay income tax and NI on your normal contractual pay earned while working during your notice period, commission, bonus, equity scheme, holiday pay, and payments in lieu of notice (PILON), and ex-gratia amount over £30,000.
Q. Should I worry about the tax indemnity clause in my settlement agreement?
No. It’s a standard clause used as part of custom and practice. We find there are rarely any tax issues once the settlement agreement is completed, but are happy to discuss it with you if you have any concerns.
Q. When can I apply my ex-gratia payment to my pension?
You can apply your ex-gratia payment to your pension when it’s:
- Part of the payment relating to the termination of your employment
- In accordance with the rules of the pension scheme in order to provide benefits to you
- Not otherwise taxable (for example, as a contractual PILON)
Check with your employment lawyer (us!) and your accountant.
Q. When might I be offered an enhanced redundancy payment?
You might be offered an enhanced redundancy payment when you’ve been with your employer continuously for at least two years (one in Northern Ireland) AND when it’s written into your employment contract, staff handbook or redundancy policy OR when your employer has entered into a collective agreement to offer enhanced terms OR when your employer has consistently paid enhanced terms in the past. There may be other circumstances in which employers offer these.
Q. What do I have to do to get an enhanced redundancy payment?
To receive the enhanced payment, you’ll probably have to sign a settlement agreement signing away your rights to bring your former employer to court.
Q. What’s the law that applies to the £30,000 tax exemption for ex-gratia payments?
The law that applies is s.403 Income Tax (Earnings and Pensions) Act 2003.
Q. What’s the law that applies to pension arrangements for ex-gratia payments?
The law that applies is section 408 Income Tax (Earnings and Pensions) Act 2003.
Q. What’s the law that applies to ex-gratia redundancy payments?
The law that applies is section 401 to 416 Income Tax (Earnings and Pensions) Act 2003.
Q. What’s the law that applies to disability and ex-gratia payments?
The laws that apply Are the Finance Act 2018 and section 406 Income Tax (Earnings and Pensions) Act 2003.
What this means to you
It’s important to get expert legal advice about whether to accept an ex-gratia payment. That’s where we can help. We are employment lawyers who only ever act for employees, never for employers.
If you make a claim for unfair dismissal or discrimination, for example, we may be able to help you negotiate an ex-gratia payment on top of the legal minimum your employer would have to pay.
As you can see, it’s a complex situation, and you’ll benefit from having an expert on your side. Give us a call and we’ll explain the legal and tax implications.
Related reading
If you found this information useful, you might also like to read other articles on similar subjects:
- I want to leave my job
- Do I have to sign a settlement agreement on redundancy?
- Can I get compensation for victimisation?
- I’ve been offered a settlement agreement. What do I do?
- What NOT to do when you’re offered a settlement agreement?
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