VII Settlement payments: a taxing matter
It’s done! Settlement negotiated. Agreement signed. And you got everything you asked for: an agreed reference, and a nice tax-free wedge. Yes, you will have to pay tax as usual on the salary part. But the rest, that’s “ex gratia” – no tax payable as it comes within the £30,000 tax-free exemption. Better still, they paid you in lieu of notice. They gave you the option to work out your notice but, truth be told, you wanted out of there! So, as well as the reference and the tax-free money, you get paid for hours you don’t even need to work. “This nearly seems too good to be true!” you tell yourself, as you await payment.
And you’re correct. It is too good to be true! If you want to find out why, skip to the last section on Post Employment Notice Pay [PENP] which explains why, in the scenario we outlined above, the taxman ended up with somewhat more and you ended up with somewhat less than you expected to land in your account as part of the settlement deal.
How to read this chapter on tax
The scenario highlights how a financial package may include more than one element, in this instance at salary, an ex gratia payment, and a payment in lieu of notice (PILON). Once all of those elements are identified, HMRC’s approach is to look at each element separately following the 4-step structure set out in the next paragraph. The £30,000 tax-free exemption only comes into play for an element if “no” has been answered to the first three steps.
HMRC doesn’t tax settlement payments randomly. It applies a structured framework to decide what is taxable, what can fall within the £30,000 exemption, and what is always taxed as earnings. Understanding that framework makes it much easier to spot problems, avoid surprises, and structure a deal properly before you sign.
4 steps to reach £30,000 tax-free
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1. Is the payment given for doing the job?
If a payment is something you were already entitled to under your contract, HMRC taxes it as normal earnings so the £30,000 exemption doesn’t apply.
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2. Is the payment related to new restrictions?
Payments made in return for agreeing to restrictive undertakings are always taxable, regardless of amount. They never fall within the £30,000 exemption.
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3. Do special tax rules apply to the payment?
Some payments sit in their own tax category and bypass the £30,000 analysis entirely. These are less common, but they’re easy to miss if you don’t know they exist.
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Is the payment fully ex gratia?
The first £30,000 of qualifying termination payments can be paid tax-free, unless all or part of the payment represents PENP.
The 4 steps the taxman takes to assess the employer’s settlement payments to you
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Is the payment "general earnings"?
What this covers
Salary up to termination
Accrued but untaken holiday pay
Contractual bonuses or commission
Notice pay for notice not worked (PILON and PENP)
Why it matters
If a payment is something you were already entitled to under your contract, HMRC taxes it as normal earnings. Labels don’t help. Calling it “compensation” doesn’t change the result. -
Is the payment given for agreeing to "restrictive covenants"?
Box 2: Restrictive covenant payments
What this covers
Payments for non-compete obligations
Non-solicitation or non-dealing restrictions
Extended restraints added under the settlement
Why it matters
Payments made in return for agreeing to restrictions are always taxable, regardless of amount. They never fall within the £30,000 exemption.If new restrictions are introduced, they must be supported by separate consideration — but they are still fully taxable.
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Do other specific tax charges apply?
Box 3: Other specific tax charges
What this covers
Employer-financed retirement benefits
Certain benefit-related payments
Payments with bespoke statutory tax rules
Why it matters
Some payments sit in their own tax category and bypass the £30,000 analysis entirely. These are less common, but they’re easy to miss if you don’t know they exist. -
Is the ex gratia payment subject to PENP?
Box 4: Termination payments (the £30,000 exemption)
What this covers
Genuine compensation for loss of employment
Non-contractual redundancy pay
Ex gratia payments not replacing earnings
Why it matters
The first £30,000 of qualifying termination payments can be paid tax-free, unless all or part of the payment represents PENP.The £30,000 exemption applies per termination, not per tax year.
H2: How to keep your options open at the start
Asking for time (Acas 10 days)
Keeping notes
Subject to contract
Not resigning
Speaking to a solicitor early
(time, notes, subject to contract, not resigning, speaking to a solicitor)
H2: Why the first offer is not the final offer
(Expanded explanation — no repetition elsewhere)
(expectation of pushback, flex, why opening offers are conservative)
H2: What actually moves an offer
(Risk, cost, timing, tone — once, properly)
(risk, cost, timing, tone — explained once, properly)
H2: What you can negotiate xxx
(financial, non-financial, practical, clean-up)
H2: How to negotiate calmly and strategically
(Psychology, anchoring, framing, avoiding escalation)
H2: What employees typically negotiate xxx
(Money vs non-money vs clean-up, with examples)
H2: Picking your battles
(Focus, priorities, avoiding scattergun asks)
H2: Deciding whether to accept the deal
(What you’re getting vs what you’re giving up; certainty vs principle)
Key takeaways from the negotiation process
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The first offer is rarely final
- Employers expect some pushback
- Initial offers are usually conservative
- Flex is often built in
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What actually moves an offer
- Legal risk
- Cost and disruption
- Timing and tone
Key takeaways from the negotiation process
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The first offer is rarely final
- Employers expect some pushback
- Initial offers are usually conservative
- Flex is often built in
……………………………….
Employers expect some pushback
Initial offers are usually conservative
Flex is often built in on money, timing, and wording
Asking questions is normal, not hostile
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What actually moves an offer
- Legal risk
- Cost and disruption
- Timing and tone
………………….
Legal risk (claims, process flaws, discrimination)
Cost (time, management effort, legal spend)
Timing (restructures, exits, announcements)
Tone (measured requests tend to work better than threats)
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What you can negotiate
- Money and tax structure
- Non-financial terms
- Practical clean-up points
………………
Financial terms (compensation, pension contributions)
Non-financial terms (references, announcements, non-disparagement)
Practical points (notice, garden leave, early release)
Clean-up clauses (restrictions, clawbacks, loans)
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How to negotiate without escalation
- Ask for time
- Stay measured
- Pick priorities
………………
Ask for time and space
Keep discussions subject to contract
Frame counteroffers clearly and calmly
Pick two or three priorities, not everything
Key takeaways: negotiating
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1
Being offered a settlement agreement does not mean you have done something wrong.
2
Employers usually act early to control risk, cost, and uncertainty.
3
The timing of an offer is about leverage and control, not blame.
4
The first offer is rarely the employer’s best or final position.
A settlement agreement is a proposal and does not have to be accepted.