Ex gratia payment: definition, tax and HR guide (2026)

HR teams regularly need to explain why one payment is taxable and another is not.

Ex gratia payment is a voluntary employer payment made without any legal obligation — from Latin “out of grace.” Common in redundancy settlements and termination agreements. UK: termination payments up to £30,000 may be tax-free under ITEPA 2003.

What “ex gratia” means in employment law

The phrase ex gratia distinguishes voluntary payments from entitlements. When an employer makes a payment “without admission of liability,” that language signals ex gratia intent: the company acknowledges no wrongdoing and accepts no legal duty to pay. This matters in three ways:

• No precedent: a single ex gratia payment does not automatically create a contractual right to future payments for the same employee or colleagues in similar roles.
• Tax treatment differs: genuinely voluntary payments may fall within the £30,000 Income Tax exemption under s.401 ITEPA 2003 (UK), whereas contractual payments or payments covering notice do not.
• Settlement context: ex gratia payments in settlement agreements are separate from compensation for claims such as unfair dismissal or discrimination, which are dealt with in other clauses.

Ex gratia payment vs statutory pay: key differences

HR teams regularly need to explain why one payment is taxable and another is not. The table below maps the most common termination payment types:

Key point: All six payment types can appear in the same termination package. The £30,000 exemption is an aggregate cap across all qualifying termination payments from the same event — not a separate allowance per payment type.

UK tax rules: the £30,000 threshold and penp

Under Section 401 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003), the first £30,000 of a qualifying termination payment is exempt from Income Tax. This threshold has been frozen since 1988. HMRC’s 2026/27 guidance confirms no uprating is currently scheduled.

What qualifies for the exemption:

• Statutory redundancy pay
• Enhanced redundancy pay above statutory minimum
• Genuine ex gratia payments where no notice period is embedded
• Compensation for loss of office not related to notice

What does not qualify:

• Any element covering a notice period not worked (post-employment notice pay, or PENP)
• Contractual PILON (payment in lieu of notice)
• Holiday pay accrued but unpaid
• Bonuses or commissions earned before termination

Penp: the most common misclassification risk

Since April 2018, HMRC requires employers to extract the PENP element from any termination payment before applying the £30,000 exemption. PENP equals the basic salary the employee would have earned during any unworked notice period, minus any contractual PILON already paid. That amount is fully subject to PAYE Income Tax and Class 1 National Insurance — regardless of what the payment is labelled in the settlement agreement.

Practical example: an employee with a three-month notice period is paid £40,000 as a combined redundancy and ex gratia settlement. If their monthly salary is £5,000 and they work none of the notice period, £15,000 is PENP (taxable). The remaining £25,000 is within the £30,000 exemption and tax-free. Had the employer labelled the full £40,000 as “ex gratia,” the PENP rules would still apply — HMRC looks at substance, not labels.

Employer national insurance from april 2020

From April 2020, employers pay Class 1A National Insurance contributions on the portion of termination payments that exceeds £30,000. Employees do not pay National Insurance on amounts within the exemption, but Income Tax applies on anything above £30,000 at the employee’s marginal rate.

US context: ex gratia and severance

US employment law has no direct equivalent to the UK’s statutory redundancy scheme or the £30,000 tax exemption. In the US, most employer-initiated severance payments are discretionary (ex gratia in substance), unless a written severance policy, employment contract, or collective bargaining agreement creates a legal entitlement.

Key US considerations:

• Tax: Severance payments are treated as ordinary wages by the IRS — fully subject to federal income tax, FICA (Social Security and Medicare), and applicable state taxes. There is no US equivalent of the £30,000 tax-free threshold.
• WARN Act: Under the Worker Adjustment and Retraining Notification Act, employers with 100+ employees must give 60 days’ notice for mass layoffs. Failure to comply may trigger back pay liability — separate from any voluntary severance.
• Release agreements: US employers typically require a signed release of claims (ADEA waiver for employees 40+) in exchange for severance above minimum entitlements. The voluntary nature of the payment gives the employer leverage to condition it on a release.
• ERISA: If a severance plan is documented and covers a class of employees, it may constitute an ERISA welfare benefit plan, adding regulatory requirements around plan documents and claims procedures.

Without-prejudice vs ex gratia: a common confusion

These two terms are often used together but describe different things:

In practice, well-drafted settlement agreements use all three concepts together: the offer is made “without prejudice and as a protected conversation,” the payment is described as “ex gratia and without admission of liability,” and a formal compromise clause records the agreed terms.

Ex gratia payment in redundancy: HR process steps

When using an ex gratia top-up as part of a redundancy package, HR teams should follow a documented process to manage tax, legal, and employee-relations risk:

1. Calculate statutory redundancy pay (SRP) using the government’s redundancy calculator (age bracket, weekly pay capped at £643/week in 2025/26, years of service).
2. Determine any contractual enhanced redundancy from the employment contract or collective agreement.
3. Calculate PENP using the formula in s.402D ITEPA 2003 — confirm with payroll or a tax adviser before drafting the settlement.
4. Set the ex gratia top-up amount such that SRP + enhanced redundancy + ex gratia does not exceed £30,000 if full tax efficiency is the goal, or document the excess and apply PAYE accordingly.
5. Draft the settlement agreement with “without admission of liability” and “ex gratia” language; include a full and final settlement clause.
6. Independent legal advice: Under UK law, employees must receive independent legal advice for a settlement agreement to be binding. Budget for a contribution to their legal fees (typically £300-£500 + VAT).
7. Process payroll: Apply PAYE to PENP and to any amount above £30,000; report via RTI on or before payment date.
8. Retain documentation: Keep the settlement agreement, payroll calculations, and PENP workings for at least six years (HMRC enquiry window).

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Documentation requirements

HMRC compliance reviews increasingly target termination payments. The documents HR should retain for each ex gratia payment:

• Signed settlement agreement with ex gratia and without-liability language
• PENP calculation workings (showing monthly salary, notice period length, any contractual PILON)
• Payslip or payroll record showing PAYE applied to PENP and any amount above £30,000
• RTI (Real Time Information) Full Payment Submission to HMRC
• Board or management approval memo for any payment above a defined threshold (typical for listed companies and FTSE 350 governance standards)
• Evidence of independent legal advice obtained by the employee

Common HR mistakes with ex gratia payments

• Labelling PILON as ex gratia: Since April 2018, all PILON is subject to PAYE. Labelling it “ex gratia” does not change the tax position — HMRC applies PENP rules regardless of the label.
• Ignoring the aggregate cap: Teams sometimes treat the £30,000 exemption as applying separately to SRP and to the ex gratia element. It is a single combined cap.
• No board approval: For senior executives, payments above salary may require remuneration committee approval and, in public companies, disclosure in the directors’ remuneration report.
• Breach of GDPR: Settlement agreements that include confidentiality clauses must not prevent employees from reporting data breaches to the ICO or whistle-blowing under PIDA — such clauses are void.
• US: failing to comply with ADEA: For employees aged 40+, a release of age discrimination claims under ADEA requires 21 days to consider and 7 days to revoke. A rushed signature may invalidate the release.

Ex gratia payment FAQ

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Frequently asked questions

Is an ex gratia payment taxable in the UK?

Ex gratia payments may be tax-free up to the £30,000 aggregate exemption under s.401 ITEPA 2003. However, any portion that constitutes post-employment notice pay (PENP) is fully taxable as earnings regardless of how the payment is labelled. Amounts above £30,000 are subject to Income Tax at the employee’s marginal rate and employer Class 1A National Insurance.

What is the difference between ex gratia and statutory redundancy pay?

Statutory redundancy pay is a legal entitlement under the Employment Rights Act 1996, calculated by age bracket, weekly pay (capped at £643 in 2025/26), and years of service. An ex gratia payment is voluntary with no legal basis. Both count toward the £30,000 combined tax-free threshold, so the ex gratia element reduces the remaining tax-free headroom.

Can an employer refuse to make an ex gratia payment?

Yes. By definition, an ex gratia payment carries no legal obligation. An employer can choose not to offer one, change the amount before agreement, or withdraw an offer before the settlement agreement is signed. Once a binding settlement agreement is signed, the payment becomes a contractual debt enforceable in the courts.

Does an ex gratia payment affect benefits or pension?

In the UK, ex gratia payments do not count as pensionable pay and are not included in final salary or average earnings pension calculations. For benefits purposes, Jobseeker’s Allowance (now Universal Credit) may be affected if HMRC treats part of the payment as earnings linked to a notice period. Employees should check with DWP if claiming benefits after termination.

What is PENP and why does it matter for ex gratia payments?

Post-employment notice pay (PENP) is the portion of a termination payment that represents unworked notice. Since April 2018, HMRC extracts PENP from any termination payment and taxes it as earnings before the £30,000 exemption applies. Misclassifying PENP as ex gratia is one of the most common termination-payment errors in HMRC compliance reviews and can trigger inaccuracy penalties.

How should HR document an ex gratia payment?

HR should retain a signed settlement agreement with ex gratia and without-liability language, PENP calculation workings, a payroll record showing correct PAYE treatment, and the RTI Full Payment Submission to HMRC. For senior executives, a board or remuneration committee approval memo is required. Retain all documents for at least six years.

Is a US severance payment the same as ex gratia?

Most US severance is ex gratia in substance — voluntary and not required by law — unless a written severance policy, employment contract, or union agreement creates an entitlement. Unlike the UK, the US has no tax-free threshold for severance; all payments are treated as ordinary wages subject to federal income tax, FICA, and state taxes.

What is ‘without prejudice’ and how does it relate to ex gratia?

Without prejudice protects the content of settlement negotiations from being used as evidence in tribunal or court. Ex gratia describes the voluntary, no-liability nature of the payment itself. Settlement offers are typically made “without prejudice and ex gratia” to combine both protections. Using without-prejudice language does not alter the tax treatment of any payment made under the agreement.