Ex gratia is Latin for "by favour". An ex gratia payment is one made voluntarily, with no legal or contractual obligation to make it. In UK employment it usually means a goodwill payment to a departing employee. If it is paid in connection with the end of employment, the first £30,000 is normally tax-free. In charities in England and Wales, it means a "moral payment" that trustees can make without Charity Commission authority up to a limit set by the charity's income, from £1,000 to £20,000.
What makes a payment ex gratia
The defining feature is the absence of obligation. If the contract, a staff handbook, a court order or settled practice requires the payment, it is not ex gratia, whatever the paperwork calls it. HMRC's National Insurance Manual makes the same point: the term should be used only for a payment the employer makes when under no legal or contractual obligation to do so.
Calling a payment ex gratia does not change its tax treatment on its own. Tax follows what the payment is actually for, and HMRC will look past the label to the facts.
Ex gratia payments on leaving employment
This is the most common use of the term. Employers often add an ex gratia sum to a redundancy or settlement package, usually in exchange for the employee signing a settlement agreement. HMRC's guidance requires each element of a termination package to be considered in a fixed order:
- Earnings (section 62 ITEPA 2003). Is it really pay for work, such as a bonus, notice pay or holiday pay? If so, it is taxed in full with National Insurance;
- Restrictive covenants (section 225). A payment for the employee agreeing to restrict their future activities is taxed under this section;
- Retirement or death benefits (section 394). Is it a benefit from an employer-financed retirement benefits scheme? HMRC notes that such a scheme can be an informal arrangement, even a decision taken at a meeting;
- Termination payments (section 401). Only if none of the above applies is the payment treated as made in connection with the termination.
A genuine ex gratia payment that reaches step 4 is taxable only to the extent it exceeds £30,000 (section 403). The excess is taxed through PAYE, and the employer pays Class 1A National Insurance on it, at 15% for 2026/27. No employee National Insurance is deducted, because a genuine compensation payment is not earnings for Class 1 purposes. HMRC's guidance confirms the income tax charge applies "even if not paid under a legal obligation", so the voluntary nature of the payment does not take it outside the regime.
The retirement trap
The third step catches many employers out. An ex gratia lump sum paid because someone is retiring, for example in recognition of long service, can be a "relevant benefit" under the employer-financed retirement benefits scheme rules. Section 394 then generally taxes the full amount as employment income, with no £30,000 exemption. HMRC reads "retirement" broadly. Its examples include a long-serving employee who leaves at 60 to take a senior post with another company.
There is an exception for ill health. A payment made because of ill health or disablement during service is not a relevant benefit, so it falls back under section 401, where it may qualify for the separate exemption for payments on account of injury or disability. The facts, and the wording of the board minute or letter, matter.
Ex gratia payments during employment
A one-off ex gratia payment to someone who is still employed is rarely free of tax or National Insurance. In Hamblett v Godfrey the courts held that a payment does not have to reward services to be taxable as earnings. It is enough that it is referable to the employment and nothing else. HMRC applies the same principle for National Insurance and expects very few payments described as ex gratia to escape it. HMRC's own example is an assembly-line worker who receives an unexpected payment for unpaid work as secretary of the works sports club. That payment is ex gratia, but it is still earnings, because it would not have been made to someone who was not an employee. HMRC also says that an ex gratia payment to a serving director of a small company is unlikely to be accepted as anything other than earnings.
Ex gratia payments by charities
Charities can normally spend money only on their charitable purposes. The Charity Commission's guidance CC7 recognises that trustees may sometimes feel morally obliged to make a payment anyway. A common example is honouring a donor's clear intention when a will left the charity more than the donor later wanted it to have. The test is whether the trustees could reasonably be regarded as being under a moral obligation to make the payment.
Section 331A of the Charities Act 2011, which applies in England and Wales, lets trustees make such a payment, or waive the charity's entitlement to property, without Commission authority up to a threshold based on the charity's gross income in its last financial year:
| Gross income in last financial year | Maximum without Commission authority |
|---|---|
| Up to £25,000 | £1,000 |
| Over £25,000 up to £250,000 | £2,500 |
| Over £250,000 up to £1 million | £10,000 |
| Over £1 million | £20,000 |
Above the threshold, the trustees must get the Commission's authority under section 106 before paying. The Commission says that a payment cannot be split to stay under the limit. The power can also be restricted or excluded by the charity's own trusts.
Practical points
- Document the reason. Record why the payment is being made. For tax, the reason decides which charge applies;
- Do not rely on the label. A payment called ex gratia that is really deferred pay or a bonus is taxed as earnings;
- Check for retirement. If the person is leaving at or near retirement, consider section 394 before assuming the £30,000 exemption applies;
- Charities. Check gross income for the last financial year against the section 331A table before committing.
Sources: HMRC NIM02140; HMRC NIM02510; HMRC EIM12810; ITEPA 2003, section 403; Charities Act 2011, section 331A; Charity Commission CC7. See also our guides to termination payments and severance pay.
Acumon's employment tax team can review how a proposed payment will be taxed, and our charity accountants advise trustees on moral payments.