Ex gratia payment

‘Ex gratia payment’ is a commonly used term in settlement agreements & employment disputes, but obviously it is not a common term in the English language. If you’re reading this you probably have a number of questions about a possible settlement agreement ‘ex gratia’ payment. To calculate roughly how much your ex gratia payment should be, try our Settlement Agreements Calculator. You might also want to read more on our How Much Money Should I Get article.

‘Ex gratia’ is the Latin for ‘as a favour’

In settlement agreements and employment disputes, this means that it is technically a payment which your employer is not obliged to make under your contract of employment. For such non contractual payments, there is tax break whereby up to £30,000 is not subject to income tax or NI deductions. Your employer just pays you the ex gratia payment, and then at the end of the tax year you declare it on an HMRC form, tick the box marked ‘ex gratia’, and you are not taxed on it.

In the mid nineties, the government decided to introduce this tax break for ex gratia settlement agreements in order to encourage people to settle their disputes early and out of court. If you went to an Employment Tribunal and won a claim there, you don’t get this tax break. The reason that this tax break exists is as that the government funds employment tribunals, including paying for the judges and the courtrooms and so on, and this is expensive. Therefore it makes sense to offer tax breaks to encourage early settlement.

In redundancy situations, any statutory redundancy pay and any lump sum can be made into an ex gratia payment in a settlement agreement. There is no obligation to give an ex gratia payment, but it is very common to do so because both sides want to bring the employment to an end.

In relation to any sums over £30,000, the tax-free status is more tricky. One way to not pay tax on any amount over £30,000 is to pay it into a pension. Unfortunately this may lock in most of the capital, and so may be favoured more if you are nearing your retirement. See our article called Pension contributions & tax on lump sums

In discrimination cases, it is theoretically possible for an employer to pay an amount as damages for discrimination, and this is regarded by HMRC as tax free. The problem here is that employers don’t want to make admissions of guilt, and therefore such a settlement agreement structure would take careful wording by an expert legal adviser.

Ex gratia and notice periods

Another tricky area is in relation to notice period. If your contract entitles you to say one month’s notice, then your employer can structure a settlement agreement so that you effectively receive this tax free. They can say ‘we are terminating your employment without notice’, thus technically breaching your contract, and then pay you an ex gratia payment instead. However, many employers shy away from this and decide to tax at source the sum equivalent to any notice pay.

The exception to this rule is where you have a mandatory ‘payment in lieu of notice’, or ‘PILON’ clause (although this is very rare). In this situation, you are entitled to receive payment instead of being asked to work out your notice period. Therefore your employer can’t pay your notice pay ‘ex gratia’ because you are entitled to it under the contract, rather than receiving is as a favour. There is more about this technical area on our Payment in Lieu of Notice page.

Negotiating a tax-efficient deal

It normally easy to have any ‘damages’ or ‘compensation’ to be paid ex gratia. The snag which you will tend to hit is negotiating notice pay to be paid ‘ex gratia.’ Unfortunately, a lot of employers are paranoid about tax liabilities and are often unwilling to structure your pay-out in a tax efficient way just in case it leaves them exposed. It can be difficult to approach your HR department with the right technical knowledge and the air of confidence required to convince them to structure your settlement agreement in a way which leaves you and the employer better off rather than the taxman.

If you want to discuss this or any other settlement agreement query, including finding out more about how much it would cost for us to represent you, click here to arrange a confidential telephone appointment , email [email protected], call 0800 533 5134 or 020 7717 5259.