Employment Tribunal Compensation and Tax 2026/27: What You Keep

Winning an employment tribunal claim can feel like a huge relief -- but the tax treatment of your award is often misunderstood. Different elements of an ET award are taxed in very different ways. Some are completely tax-free; others attract income tax and National Insurance at your marginal rate. Understanding the rules before your award is settled can help you structure it efficiently and avoid unexpected bills from HMRC.

The Basic Award: Tax-Free Statutory Compensation

The basic award is the minimum compensation you receive if you win an unfair dismissal claim. It is calculated using exactly the same formula as a statutory redundancy payment:

• Half a week's pay for each complete year of service when you were under 22
• One week's pay for each complete year when you were aged 22 to 40
• One and a half week's pay for each complete year when you were 41 or over

The weekly pay used in this calculation is capped at GBP 719 (2026/27). The maximum number of years that count is 20, giving a maximum basic award of GBP 21,570.

Because the basic award mirrors the statutory redundancy payment, HMRC treats it identically: it falls within the GBP 30,000 tax-free termination payment exemption. The full basic award is free of income tax and National Insurance, even if it represents several years of service. The only exception is where the basic award forms part of a contractual entitlement -- in that case, it may be treated as earnings and taxed in full.

The Compensatory Award and the GBP 30,000 Exemption

The compensatory award compensates you for the financial losses caused by your unfair dismissal -- lost earnings, loss of benefits, future loss of earnings, and loss of statutory rights. In 2026/27 the statutory cap on the compensatory award is GBP 118,223 (or 52 weeks' gross pay, whichever is lower).

The critical tax rule is that the first GBP 30,000 of all termination payments combined is tax-free. This GBP 30,000 pool is shared between the basic award and the compensatory award. Once the total of those payments exceeds GBP 30,000, the excess is fully taxable.

Worked Example: GBP 53,000 Total Award

Consider an employee who receives the following:

The GBP 30,000 exemption covers the first GBP 30,000 of the combined total. Because GBP 8,000 of the basic award uses up GBP 8,000 of that pool, only GBP 22,000 of the compensatory award is tax-free. The remaining GBP 23,000 of the compensatory award is taxable.

If you are a higher-rate taxpayer, you would owe income tax at 40% plus employee NI at 2% on that GBP 23,000, giving a combined deduction of approximately GBP 9,660. Your net receipt after tax on the taxable element would be around GBP 13,340.

Injury to Feelings: Vento Bands and Tax-Free Status

Where your claim includes discrimination -- such as unfair treatment on grounds of sex, race, disability, or religion -- the tribunal can award compensation for injury to feelings. These awards are assessed using the Vento bands, which are uprated periodically for inflation.

Vento Bands 2026/27

All injury to feelings awards are tax-free. HMRC accepts that they compensate for a personal wrong -- the emotional distress and humiliation caused by discriminatory treatment -- rather than for lost earnings. They are not employment income and do not form part of the GBP 30,000 termination payments pool.

However, be cautious about how the award is described in any settlement agreement. If a payment is labelled as injury to feelings but actually compensates for lost earnings or future losses, HMRC may reclassify it on review. The label alone does not determine the tax treatment; substance matters.

PENP: Post-Employment Notice Pay

PENP is one of the most important -- and frequently misunderstood -- rules in termination payment taxation. Introduced in 2018, PENP ensures that notice pay cannot be disguised as a tax-free termination payment.

The PENP formula is:

PENP = (BP / D) x P

Where:

• BP = the employee's basic pay in the last pay period before the trigger date
• D = the number of days in that pay period
• P = the number of days in the post-employment notice period (the unworked notice)

PENP Worked Example

Sarah earns a salary of GBP 4,000 per month and is dismissed without working her three-month contractual notice period. She receives a termination payment that includes compensation for that unworked notice.

• BP = GBP 4,000 (last month's basic pay)
• D = 30 (days in last pay period)
• P = 92 (days in 3-month notice period)

PENP = (GBP 4,000 / 30) x 92 = GBP 12,267

This GBP 12,267 is treated as taxable earnings -- fully subject to income tax and National Insurance through PAYE -- regardless of whether Sarah's contract had a payment in lieu of notice clause. It does not benefit from the GBP 30,000 exemption.

Any termination payment above the PENP and above the GBP 30,000 threshold is also taxable. PENP effectively sits outside the GBP 30,000 pool and must be taxed first.

How Employers Operate PAYE on Tribunal Awards

Where a tribunal order or settlement contains taxable elements, the employer -- or whichever party is making the payment -- must operate PAYE before paying over the net amount. The process works as follows:

1. Identify the taxable elements: calculate PENP first, then identify any compensatory amount above the GBP 30,000 threshold
2. Calculate income tax and NI: apply the employee's tax code and the appropriate NI rate (8% on earnings up to the upper earnings limit in 2026/27, 2% above)
3. Deduct via payroll: process the payment through the payroll system and submit an RTI Full Payment Submission to HMRC
4. Issue documentation: give the employee a payslip or written breakdown showing the gross award, each element, the tax and NI deducted, and the net payment

Employees should check that the breakdown they receive correctly identifies the tax-free and taxable portions. If an employer has deducted too much -- for example, by treating a genuine injury to feelings award as taxable -- you can reclaim the overpaid tax through Self Assessment or by contacting HMRC directly.

Summary: Tax Treatment at a Glance

Understanding these distinctions before agreeing a settlement is essential. Structuring the award correctly -- maximising the tax-free injury to feelings element where genuine, for example -- can materially change your net outcome.

Our redundancy and termination payment calculator lets you enter the different elements of an ET award and see your estimated net receipt after tax. It accounts for PENP, the GBP 30,000 exemption, and your income tax band so you can compare settlement offers on an after-tax basis before signing any agreement.