We are often asked many questions about ex gratia payments and whether they need to go through payroll. Here is an example of the some of most common questions we encounter from both employees and employers regarding Settlement Agreement Ex Gratia Payments:
- What is an ex gratia payment?
- Do Ex Gratia Payments Go Through Payroll?
- Is an Ex-Gratia Payment Taxable?
- Ex gratia payment wording – what are the pitfalls?
- How to negotiate ex gratia payments. What’s the best way to negotiate a settlement agreement ex gratia payment?
1. What is an Ex-Gratia Payment
In almost all Settlement Agreements, they payments are offered by an employer to an employee.
Other names
Such payments are also known as a Termination Payment, Compensatory Payment, Golden Handshake, or a Non-Contractual Payment in Lieu of Notice (PILON).
Definition
Ex Gratia refers to a voluntary payment made by an employer to an employee. Its origin is Latin and the phrase translates to ‘by favour’ in layman’s terms.
How Ex-Gratia Payments Arise
Within the context of employment law, an ex-gratia payment refers to a voluntarily payment made by an employer to and employee. This typically occurs in circumstances such as dismissal, retirement, discrimination (see below) and redundancy.
Protected Discussions
However, even before any of these cases arise, if there are problems in the workplace, then employers and employees could also have Protected Discussions under Section 111a of the Employment Rights Act 1996.
These discussions, in the context of an employment dispute, are an “off the record” conversation on a confidential basis about the termination of an employee’s employment with a Settlement Agreement. The legislation provides the protection that details of the protected conversation will not be admissible in any future legal proceedings before an Employment Tribunal.
We regularly assist employees and employers throughout the UK with this process. We also assist with negotiating ex gratia payments in their Settlement Agreements. Our fees for advising on a Settlement Agreement are usually paid in full by the employer.
Ex-Gratia Payments in Practice
In the event of one of these scenarios, an employer may offer an employee a payment as compensation which often exceeds their entitlement as set out in their employment contract. In short, you accept the payment and waive all your employment law (and other) rights against the employer that are associated with the termination of your employment.
An ex gratia payment, therefore, is made where there is no contractual obligation to do so and without admission of liability by the employer. The definition of ex gratia indicates that each party agrees and accepts that the employer is not under a duty to provide the payment.
2. Do Ex Gratia Payments Go Through Payroll?
Normally, payments made by an employer, in respect of the work, are subject to both National Insurance and PAYE contributions. Such payments arise out of the contract of employment relationship. However, under a tax exemption, namely Section 403 Income Tax (Earnings and Pensions) Act 2003, an ex gratia payment (provided that there is no suggestion that termination was by mutual consent which may be treated as a variation of a contract rather than a breach) can be paid tax free. Compensation for the breach is required for the exemption to apply (Tax Bulletin issue 63 “Payments in Lieu of Notice”). Any amount under £30,000.00 generally can be paid tax free. Upon the termination of an employees employment, PILON, holiday pay and normal contractual pay (notice period) are subject to the normal PAYE Income Tax rules. This is also the same for National Insurance contributions.
A complexity arises that, at the time of writing of this article, there is some suggestion that HMRC believes in some circumstances that compensation discrimination occurring during employment (to which Section 401 ITEPA does not apply) because the payment is not connected with termination is potentially taxable. The distinction here is that Section 401 of ITEPA relates to a payment being connected with termination. The Pettigrew -v- HMRC (2018) case can be used as further HMRC guidance for this.
3. Are The Payments Taxable?
Generally speaking, a non-contractual payment of £30,000 and under will not be taxed under Pay-As-You-Earn (PAYE) or National Insurance Contributions (NICs). This is because these types of payment are not considered to be earnings that have accrued from work or a provided service. Instead, these are seen as a non-compulsory payment made by your employer as ‘compensation for the loss of employment’.
However, in the event that your compensatory payment exceeds the £30,000 rule of thumb, the excess amount of your payment will be subjected to taxation at a rate which is within your PAYE margins. It must be noted, however, that NICs will not be included in this taxation. This is because compensatory payments are not considered to be ‘earnings’ and thus do not require these types of contributions. Therefore, it depends on the level of the ex gratia payment whether or not part of it will be taxable but even then it is generally only subject to PAYE and not NIC.
As stated above, PILON, in respect of notice, holiday pay or any other payments associated with the employment are generally taxable in the normal way.
4. Settlement Agreement Wording
Care should be taken when drafting Settlement Agreements or signing Settlement Agreements to ensure that the ex gratia payment will qualify for the exemption. This is especially so because, often within a Settlement Agreement, there is also a tax indemnity clause assigning responsibility for all future tax to the employee.
Wording within the Settlement Agreement suggesting that the termination was “by mutual agreement”, “mutual consent”, or some other conciliatory wording should be avoided at all costs. This can raise a suggestion by HMRC that there has been a variation of a contract, rather than a breach of contract, for which compensation is being paid. A breach is a strict requirement for the £30,000.00 exemption to apply. Obviously, the true and accurate position should be reflected in any event. If there has been an agreement by mutual consent which does not benefit from the exemption, then tax may be payable upon the payment.
Both employees and employers alike should always take professional, legal advice from an Employment Law Solicitor on the ex gratia payment tax position. Employees will note that this is especially important for them given the tax indemnity Settlement Agreement clauses, which answer the question “are Settlement Agreements taxable?”. Yes, in certain circumstances, provided the exemption conditions are not met.
5. How to Negotiate Ex-Gratia Payments
Our Settlement Agreement Solicitors specialise in Employment Law Settlement Agreements and can negotiate settlements on your behalf. We can ensure that the ex gratia payment wording and tax treatment is dealt with properly to make certain that you do not fall foul of the provisions of ITEPA. This guarantees that the tax indemnity Settlement Agreement provisions will fall into place.
Freeman Jones Solicitors can also assist with ensuring that all other aspect of the Settlement Agreement are fully compliant, negotiated on the best possible terms in your favour. Our settlement agreement solicitors can also suggest additional things are inserted into the Agreement on your behalf (e.g. a reference). We can also provide an agreed reference template to assist in this regard.
Should you wish to discuss, or indeed have any other questions about Settlement Agreements, then contact us on 0333 009 0808
