Restrictive Covenant Payments in Employment: Tax Treatment 2026
Payments made for agreeing to a new or extended restrictive covenant (non-compete, non-solicit) when leaving a job are fully taxable as employment income — they don't share the £30,000 termination exemption. Here's why.
Why restrictive covenant payments are taxed differently
When employment ends, a settlement agreement or termination package can include several different types of payment, each with its own tax treatment. One frequently misunderstood element is a payment made specifically in consideration of the employee agreeing to a restrictive covenant — for example, agreeing not to join a named competitor, not to solicit former clients, or not to poach colleagues for a set period after leaving.
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Open Income Tax calculatorUnder section 225 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003), any payment made in return for giving, or agreeing to comply with, such a restriction is treated as general earnings — fully taxable employment income, with employee and employer National Insurance also applying. Critically, this type of payment gets no share of the £30,000 tax-free termination payment exemption that can apply to genuine compensation for loss of employment.
What counts as a restrictive covenant payment
| Scenario | Likely tax treatment |
|---|---|
| Employer pays £10,000 specifically for the employee to agree to a new 6-month non-compete clause on leaving | Fully taxable under s.225 ITEPA 2003 |
| Employee is simply reminded their existing contractual covenant (agreed years earlier, with no new payment now) continues to apply after leaving | No new s.225 charge — no new payment made for it |
| Settlement agreement includes a lump sum described as "compensation" but is genuinely paid, in part, in exchange for extending an existing covenant | The part attributable to the covenant is still taxable under s.225, regardless of the label used |
How this differs from the £30,000 exemption
| Payment type | Tax treatment |
|---|---|
| Genuine ex-gratia compensation for loss of employment | Tax-free up to £30,000 (combined across all ex-gratia elements); NI-free entirely, though employer Class 1A NI applies above £30,000 from April 2025 rules |
| Contractual notice pay / PILON | Fully taxable, NI applies |
| Payment specifically for a restrictive covenant (s.225 ITEPA) | Fully taxable, NI applies — no £30,000 exemption |
| Legal fees contribution paid direct to solicitor | Tax-free, NI-free |
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Open Redundancy Pay calculatorWhy employers still pay for covenants despite the tax cost
Even though a restrictive covenant payment is fully taxed, employers may still choose to pay for one because:
- It provides clearer, better-evidenced consideration for the covenant, making it more likely to be enforceable if challenged later (a covenant agreed for no fresh consideration on exit can sometimes be more vulnerable to legal challenge).
- The commercial value of preventing a departing senior employee from immediately joining a direct competitor or poaching clients can far outweigh the extra tax cost.
- It gives the employee a clear financial incentive to comply, alongside the legal obligation.
Practical points when negotiating a settlement
- Ask for a clear breakdown of how much of any settlement sum, if any, is specifically attributed to a restrictive covenant — this affects how much of the total package is genuinely tax-free.
- Understand that a larger "headline" settlement figure may include a taxable covenant payment, meaning the actual net amount received is lower than it first appears.
- Get independent legal and, ideally, tax advice before agreeing to a new or extended covenant in exchange for payment, given the full tax and NI exposure involved.
What to check on your settlement paperwork
- Whether any element is explicitly described as consideration for a restrictive covenant.
- Whether PAYE and NI have been correctly applied to that element, separately from the tax-free treatment of any genuine £30,000 ex-gratia element.
- Whether the covenant itself is reasonable in scope, duration, and geography — a solicitor reviewing your settlement agreement should assess this alongside the tax treatment.
Use the income tax calculator to estimate the net effect of a settlement package that includes a taxable restrictive covenant payment.
Frequently asked questions
Are restrictive covenant payments tax-free like part of a redundancy payment?
No. Under section 225 of the Income Tax (Earnings and Pensions) Act 2003, any payment made in return for a person giving or varying a restrictive undertaking (such as a non-compete or non-solicitation clause) is fully taxable as employment income, with no share of the £30,000 termination payment exemption.
What counts as a restrictive covenant payment for tax purposes?
Any payment made specifically in consideration of the employee entering into, or agreeing to comply with, a restriction on their conduct after leaving — for example, agreeing not to work for a competitor, not to solicit clients, or not to poach former colleagues for a defined period.
Does National Insurance apply to restrictive covenant payments?
Yes. Because the payment is treated as general earnings under section 225 ITEPA 2003, both employee and employer Class 1 National Insurance apply in the normal way, in addition to income tax.
Can a settlement agreement label a payment as 'compensation' to avoid this tax treatment?
No. HMRC and tribunals look at the true substance of what a payment is actually for, not just the label used in the agreement. If part of a settlement sum is genuinely paid in exchange for a new or extended restrictive covenant, it is taxable under section 225 regardless of how it's described.
Do existing restrictive covenants already in an employment contract trigger this tax rule when someone leaves?
Not automatically. The tax charge applies specifically to a payment made in consideration of giving or varying a covenant — simply continuing to be bound by a covenant that was already part of your original contract, with no new payment for it, doesn't itself create this specific tax charge.
Is legal advice about restrictive covenants also taxable?
No — separately, a payment made directly to a solicitor for independent legal advice on a settlement agreement (including advice about restrictive covenants within it) is tax-free and NI-free under different rules, distinct from any payment made to the employee in exchange for actually agreeing to the covenant.
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