What Is An Ex Gratia Payment In UK Employment Law?

Ending an employment relationship (or resolving a workplace dispute) is rarely just a “process” for a small business. It’s personal, it’s time-consuming, and it can feel high-stakes - especially when you’re balancing team morale, cashflow, and legal risk.

That’s why many employers ask the same question: what is an ex gratia payment in the UK, and when does it make sense to offer one?

In simple terms, an ex gratia payment is a payment you choose to make even though you’re not legally required to make it. But the details matter. If you label something “ex gratia” when it’s actually owed under the contract (or under statute), you can create tax issues, set the wrong precedent, or weaken your position in a dispute.

Below, we’ll walk you through how ex gratia payments work in the UK, when they’re used, what they should (and shouldn’t) cover, and the practical steps SMEs can take to keep things fair, consistent, and legally protected.

What Is An Ex Gratia Payment In The UK?

An ex gratia payment (Latin for “out of grace”) is a payment an employer makes voluntarily - meaning there’s no contractual term, legal obligation, or statutory requirement forcing you to pay it.

For employers, ex gratia payments commonly come up in situations like:

• Exit negotiations where you want a clean break and to reduce the risk of disputes.
• Redundancy situations where you pay an additional amount on top of statutory or contractual redundancy pay.
• Workplace grievances where you want to resolve issues pragmatically (without admitting liability).
• Business reorganisations where roles change and you’re smoothing the transition.

Importantly, an ex gratia payment is different from money the employee is already entitled to, such as:

• salary up to the termination date
• accrued but untaken holiday pay
• statutory redundancy pay (where applicable)
• notice pay (or a contractual right to notice pay)
• commission that has been earned under the contract

Those payments are usually called contractual or statutory payments - and they’re not “ex gratia” just because you decide to pay them quickly or in one lump sum.

Why SMEs Use Ex Gratia Payments

For a small business, an ex gratia payment is often a commercial decision. It’s a way to:

• reduce the likelihood of an Employment Tribunal claim (where there’s risk)
• bring a difficult situation to an end without prolonged management time
• protect client relationships and business reputation
• support a departing employee while moving the business forward

That said, it’s not a “magic solution”, and it’s not a substitute for running a fair process where one is required.

When Should You Consider Making An Ex Gratia Payment?

There’s no one-size-fits-all rule, but there are patterns where ex gratia payments are commonly used - and where they can be genuinely helpful for employers.

1) Redundancy Or Restructure Exits

If a role is genuinely redundant, you may have statutory obligations depending on eligibility and length of service. But some employers choose to offer an additional amount (ex gratia) to:

• encourage cooperation with handover
• avoid “dragging out” consultation due to mistrust or conflict
• recognise service and keep goodwill within a small team

It’s also common for businesses to get terminology mixed up here, so it’s worth being clear on severance vs redundancy before you put numbers on the table.

2) Settlement Negotiations And “Clean Break” Agreements

In many cases, an ex gratia payment forms part of a wider agreement where both sides want to move on. For example, where there are allegations of unfair treatment, performance disputes, or a breakdown in working relationship.

If you’re going down this route, you’ll usually be looking at a properly documented settlement agreement (and you’ll want the payment terms drafted carefully). You may also want to sanity-check expectations around the Settlement Agreement figures commonly seen in the UK - not because there’s a standard rate (there isn’t), but because it helps you plan.

3) When You’re Paying “Something Extra” But You Don’t Accept Liability

It’s common for ex gratia payments to be offered without admission of liability. This can be helpful where:

• you’re dealing with competing accounts of what happened
• you want to avoid a long internal dispute
• you want to protect morale and keep the wider business stable

However, “without admission” doesn’t automatically make it safe - the wording and the surrounding process still matter.

4) High-Risk Dismissal Situations

If you’re facing a potentially risky dismissal (for example, where there may be discrimination risks, whistleblowing allegations, or unclear evidence), some employers consider an ex gratia payment as part of an exit arrangement.

But be careful here. If the situation involves misconduct, you still need to follow a fair process, and you’ll want to be confident you’re handling it in line with best practice (including investigation and meetings). A useful starting point is the gross misconduct checklist approach - even if you’re not ultimately relying on gross misconduct as the reason for dismissal.

Ex Gratia Payment vs Contractual Payments: Getting The Labels Right

One of the most common mistakes we see is businesses calling a payment “ex gratia” when it’s actually contractual.

Why does that matter?

• Tax treatment can differ (and HMRC will look at substance over labels).
• Employees can challenge the classification if it affects their rights or deductions.
• You may accidentally admit an obligation if the payment is described poorly in writing.

Common Payments That Are Usually Not Ex Gratia

As an employer, you’ll typically treat these as contractual/statutory amounts (not ex gratia):

• Notice pay where you require the employee to work their notice, or where the contract entitles them to notice pay.
• PILON (pay in lieu of notice) where there’s a contractual PILON clause or you choose to terminate immediately and pay notice instead.
• Accrued holiday pay (this is a statutory entitlement).
• Statutory redundancy pay (where eligible).

If you’re considering ending employment immediately, it’s worth checking whether you’re correctly handling PILON, because missteps here can quickly turn into breach of contract arguments.

Why Your Employment Contract Matters

Whether a payment is “voluntary” often depends on what you’ve promised in writing (and what’s become custom and practice). Before you offer anything, you should check:

• the termination and notice clauses
• commission/bonus clauses
• any redundancy policy or enhanced benefits language
• any settlement or dispute resolution clauses

If you’re not confident your paperwork is up to date, it’s worth reviewing your Employment Contract templates and processes before you negotiate exits - it’s much easier to manage expectations when your contract is clear from day one.

How Are Ex Gratia Payments Taxed In The UK?

This is where many small businesses get understandably nervous, because employment tax is not an area you want to “wing”.

In broad terms, some genuine non-contractual termination payments can potentially fall within the UK’s £30,000 income tax exemption. But it’s not automatic, and the exemption does not apply to everything that gets paid at termination.

A few important caveats apply:

• HMRC looks at what the payment really is, not what you call it.
• Post-Employment Notice Pay (PENP) rules can mean part of a termination package is treated as taxable earnings if it relates to notice entitlement (even where a document refers to an “ex gratia” amount).
• Some termination amounts are always taxable as earnings (for example, wages, holiday pay, and many bonuses/commission payments).
• National Insurance contributions (NICs) may apply depending on what the payment is. As a general rule, amounts treated as earnings are subject to NICs, while the portion that genuinely qualifies as a termination payment under the £30,000 exemption is typically not subject to employee NICs (and may have different employer NIC treatment depending on the circumstances and current rules).
• Termination packages often contain a mix of taxable earnings and potentially exempt termination elements.

The Practical Employer Approach

From an SME perspective, a sensible approach is:

• Separate out the payments clearly (e.g. wages, holiday pay, notice/PILON, redundancy, and ex gratia).
• Document the reason the ex gratia element is being paid (e.g. discretionary compensation for loss of employment, goodwill, or settlement of a dispute).
• Speak to your accountant/payroll provider before processing the payment, especially if you’re considering whether any part may fall within the £30,000 exemption and how PENP/NICs apply.

And keep in mind: if an “ex gratia” payment is linked to something that looks like earnings (for example, performance bonuses or contractual incentives), the tax position may change.

Important: This article is general information only and isn’t tax advice. Tax treatment depends on the facts and HMRC practice, so it’s best to take accountant/payroll advice and legal advice on how any termination terms are documented (particularly in a settlement agreement).

How To Offer An Ex Gratia Payment: A Step-By-Step Employer Checklist

If you’ve decided an ex gratia payment is on the table, the next question is: how do you do it in a way that’s clear, fair, and doesn’t create unintended legal exposure?

Step 1: Be Clear On Your Goal

Ask yourself what you’re trying to achieve. Common goals include:

• a fast, amicable exit
• reducing dispute risk
• protecting team stability
• closing out negotiations on agreed terms

Your “why” affects how you structure the offer, what documents you need, and how you communicate it.

Step 2: Identify What You Already Owe (So You Don’t Overpay Or Mislabel)

Before negotiating any additional payment, calculate:

• final salary up to termination date
• holiday accrued but untaken
• notice pay/PILON
• any contractual bonus/commission already earned
• statutory redundancy pay (if applicable)

This helps you avoid accidentally using the ex gratia payment to cover something that should have been paid anyway.

Step 3: Decide Whether You Need A Settlement Agreement

In many situations, paying an ex gratia amount only makes business sense if you also get something in return - usually:

• a waiver of claims (so the employee agrees not to bring certain claims), and/or
• confidentiality and non-disparagement obligations, and/or
• an agreed reference

In the UK, waiving statutory employment claims is typically done via a settlement agreement (with formal requirements). If you just pay “extra” without documenting the deal properly, you may not get the protection you think you’re buying.

Step 4: Put The Terms In Writing (And Keep The Tone Professional)

Even where you’re not using a settlement agreement, you should still confirm key details in writing, such as:

• the amount and what it covers
• when it will be paid
• any deductions/tax treatment (as advised by payroll/accountants)
• whether it is discretionary and without admission of liability

If termination is happening, make sure you also handle the formalities properly, including a clear termination letter. A termination letter is often a small document that carries a lot of weight later.

Step 5: Apply A Consistent, Non-Discriminatory Approach

Consistency matters more than many employers realise. If you routinely offer ex gratia payments in certain situations, you can create:

• employee expectations (making it harder to refuse in future)
• internal fairness issues within a small team
• discrimination risk if the pattern looks inconsistent across protected characteristics

This doesn’t mean you can’t treat cases differently - it just means you should be able to justify why.

Step 6: Keep Records (In Case You Need Them Later)

Keep a clear record of:

• how the amount was calculated
• what payments were contractual vs ex gratia
• what process you followed before exit
• any communications around the offer

This is especially important if you’re dealing with a grievance, performance management history, or redundancy consultation.

Key Takeaways

• An ex gratia payment is a voluntary payment - it’s not something your business is legally required to pay under a contract or statute.
• Ex gratia payments are commonly used by SMEs to support clean exits, resolve disputes pragmatically, and reduce the risk of ongoing conflict.
• Be careful not to label contractual entitlements (like wages, holiday pay, notice pay or redundancy pay) as “ex gratia” - it can cause tax and legal confusion.
• Termination packages often include a mix of payments, and the tax treatment may vary depending on what each element actually represents (including the impact of PENP rules and NICs).
• If you’re paying an ex gratia amount to reduce claim risk, it often makes sense to document the deal properly (commonly through a settlement agreement) so you’re not paying “extra” without protection.
• Consistency, documentation, and fair process are crucial - ex gratia payments shouldn’t be used as a shortcut around proper HR and legal steps.

If you’d like help structuring an exit package, documenting an ex gratia payment properly, or reducing risk in a tricky termination, you can reach us at 08081347754 or team@sprintlaw.co.uk for a free, no-obligations chat.