Ex-Gratia Payments: Tax Treatment Explained 2026/27

An ex-gratia payment (Latin for 'out of goodwill') is a payment made by an employer to a departing employee that is not required under the employment contract and is not directly linked to services the employee has performed — commonly paid as part of a redundancy or settlement agreement, on top of any contractual notice pay, statutory redundancy pay, or other sums the employee is legally owed.

Up to £30,000 of a genuine ex-gratia termination payment can be received free of income tax, and the whole amount (including anything above £30,000, in most cases) is exempt from employee National Insurance, though from April 2020 employer Class 1A NIC does apply to the excess above £30,000, a cost borne by the employer rather than the employee.

A payment is not eligible for the £30,000 exemption if it is contractual (for example, a payment in lieu of notice that your contract entitles you to), directly linked to services you performed (like an unpaid bonus or commission owed), or restructured simply to relabel taxable pay as 'ex-gratia' without genuine substance — HMRC scrutinises this closely, and Post-Employment Notice Pay (PENP) rules specifically require any notice-related element to be taxed as employment income regardless of how it is labelled in the settlement agreement.

PENP is a specific calculation HMRC requires when someone leaves employment without working their full contractual notice period, to identify how much of any termination payment actually represents pay for the unworked notice period. This PENP amount is always taxed as normal employment income (fully subject to income tax and NI), regardless of whether the overall payment is labelled 'ex-gratia' — only the genuine, non-PENP balance of a termination payment can potentially benefit from the £30,000 exemption.

Statutory redundancy pay itself is entirely tax-free (it does not use up any of the £30,000 allowance on its own in the way some believe) but is added together with any other genuinely ex-gratia elements of a termination package when checking whether the combined non-contractual, non-PENP total exceeds £30,000 — so a £12,000 statutory redundancy payment plus a £22,000 additional ex-gratia payment would together use up the full £30,000 allowance, with tax due on any excess.

The excess above £30,000 is taxed as employment income at your marginal income tax rate (20%, 40% or 45% depending on your total income for the year, including the excess itself), though it is not subject to employee National Insurance — only employer Class 1A NIC applies to this excess, which does not reduce the employee's own net payment.

No — HMRC's PENP rules specifically prevent employers from simply relabelling notice pay or contractual entitlements as 'ex-gratia' to avoid tax. The PENP calculation is mandatory for any termination where notice is not fully worked, and understating the PENP figure to maximise the apparent tax-free amount is a compliance risk for both employer and employee if HMRC later challenges the calculation.

It can — a substantial termination payment (including the ex-gratia element) may be treated as capital for means-tested benefit purposes once received, potentially affecting Universal Credit eligibility if it pushes your savings above the relevant capital limits, even though the payment itself was tax-free for income tax purposes. Tax treatment and means-tested benefit treatment are assessed under different rules.

Yes, strongly advisable, and in fact a settlement agreement is only legally binding if the employee has received independent legal advice on its terms — this is a legal requirement, not just good practice, and the cost of that advice is often paid or contributed to by the employer as part of the settlement itself.