Non-Compete Clause Payment Tax 2026/27: Why It's Taxed as Earnings

Why covenant payments are taxed as earnings, not termination pay

When an employee leaves a job, employers sometimes pay an additional sum in exchange for the employee agreeing to a post-termination restrictive covenant — commonly a non-compete clause, but also non-solicitation or confidentiality undertakings. UK tax law treats this as fundamentally different from compensation for losing your job. Section 225 of the Income Tax (Earnings and Pensions) Act 2003 specifically taxes any payment made in return for giving, or agreeing to give, a restrictive undertaking as earnings — in full, with no partial exemption, regardless of what the settlement agreement calls it.

This matters because it sits alongside similar rules for payments in lieu of notice (PILON) and Post-Employment Notice Pay (PENP): HMRC has built a series of specific provisions to stop genuine pay-like elements of an exit package being relabelled as tax-free termination compensation. A non-compete payment is one of the clearest examples — it's pay for a promise, taxed exactly like pay for work.

What gets taxed and what doesn't in a typical settlement

The pattern across all of these is consistent: anything that's really a substitute for pay — notice, a promise not to compete, ordinary wages — is taxed as pay. Only genuine compensation for the loss of the job itself gets access to the £30,000 exemption.

Worked example: £15,000 covenant payment plus £20,000 redundancy compensation

Suppose an employee on a £45,000 base salary leaves with a settlement that includes £15,000 specifically for agreeing to a 12-month non-compete clause, plus £20,000 of genuine redundancy compensation.

The £15,000 covenant payment is added to the £45,000 salary as earnings for the tax year. There's £5,270 of headroom left in the basic-rate band before reaching £50,270:

Roughly 63% of the covenant payment survives tax and NI. Meanwhile, the £20,000 of genuine redundancy compensation falls entirely within the £30,000 exemption: it's paid tax-free and free of employee National Insurance. Check the split on your own numbers with

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The compliance risk of mislabelling

It might be tempting to describe the £15,000 as "additional termination compensation" instead of a covenant payment, to try to shelter more of it within the remaining £10,000 of exemption headroom (£30,000 minus the £20,000 already used). This isn't a legitimate planning option — if HMRC establishes that the payment was genuinely made in return for the restrictive covenant, the correct earnings-based tax treatment applies regardless of the label used, and the employer can face liability for unpaid PAYE tax and National Insurance, plus potential penalties and interest.

| Approach | Tax treatment | Risk |

|---|---|---| | Correctly labelled as covenant payment | Taxed in full as earnings (£9,437.80 net of £15,000) | Compliant | | Incorrectly labelled as termination compensation | Partially or fully treated as tax-free/NI-free | HMRC challenge, back tax, penalties for employer |

The lesson isn't that mislabelling saves money — it's that it creates a liability that surfaces later, often at the employer's cost, and can also affect the employee if HMRC later reassesses the payment.

Employer cost comparison

Beyond the employee's own tax and NI, the employer also pays employer National Insurance at 15% on the correctly-taxed covenant payment, since it's treated as ordinary earnings:

This is a further reason covenant payments and genuine compensation need to be clearly separated in the settlement paperwork — they carry very different costs for the employer as well as different outcomes for the employee.

What this means if you're negotiating an exit package

• Ask what each element of the settlement is actually for. A single lump sum figure can hide very different tax outcomes depending on how it's split between notice pay, covenant payment and genuine compensation.
• Don't assume a bigger headline number is better after tax. £15,000 labelled as covenant payment nets around £9,438; the same £15,000 correctly treated as exempt compensation (if genuinely available and within the £30,000 cap) would be fully tax-free.
• Check the interaction with your other termination elements using
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  Redundancy Pay Calculator

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  for the compensation side and
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  for the earnings side, so you understand your total net position before signing.

Bottom line

A payment for a non-compete or restrictive covenant clause is taxed exactly like ordinary pay — income tax and National Insurance in full, with no access to the £30,000 termination exemption, whatever the settlement agreement calls it. If your exit package includes both a covenant payment and genuine redundancy compensation, expect them to be taxed very differently, and get the split checked properly before you sign, ideally with regulated advice for anything beyond a modest amount.