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In the complex world of employee compensation and benefits, the term ‘ex gratia payment’ often surfaces, particularly during discussions about termination settlements, redundancy or other circumstances. As an employer, it is important to understand ex gratia payments, how they work in practice, and the implications they can carry. This article will simplify the complexity associated with ex gratia payments and provide practical guidance on their usage.
What is an Ex Gratia Payment?
In the simplest terms, an ex gratia payment is a payment made by an employer to an employee that is not required by law, contract, or obligation. The term ‘ex gratia’ derives from Latin and quite literally means ‘by favour’. This payment is based on goodwill or discretion, as opposed to a legal obligation such as statutory redundancy pay.
Key Characteristics of Ex Gratia Payments
Voluntary Nature
On a basic level, an ex gratia payment is a payment that you, as an employer, make at your own discretion. As such, it is not something that an employee can claim as a right.
Non-contractual
Unlike the payment of an employee’s salary, bonuses, or other contractual benefits, an ex gratia payment is not usually stipulated in the employee’s contract of employment. Therefore, there is usually no contractual obligation on you to make this payment.
Compensation
In reality, employers often use ex gratia payments as compensation. This includes situations such as:
- redundancy;
- settlement agreements to resolve disputes; and
- a gesture of goodwill upon the termination of a contract.
If you are considering making employees redundant, you may offer ex gratia payments in addition to statutory redundancy pay. This will likely mitigate the impact of redundancy and help maintain good employee relations. Additionally, by ending a working relationship on amicable terms, you can prevent potential disputes from arising in the future.
If you are in a dispute with an employee, you may also offer an ex gratia payment to persuade them not to take the claim to court. However, it is important to remember that this is ultimately a voluntary, non-contractual payment.
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Tax Implications
One of the most significant aspects of ex gratia payments is their tax treatment. Generally, ex gratia payments can be paid tax-free up to a certain limit. The current limit as of July is £30,000. This means that if the total of the ex gratia payments made to an employee upon termination does not exceed £30,000, then it is exempt from income tax and national insurance contributions.
However, it is important to note that:
- any amount over £30,000 is taxable; and
- ex gratia payments are only tax-exempt if they are genuinely ex gratia. Payments that are contractual or arise from contractual obligations, such as unpaid bonuses or notice pay, are fully taxable.
For more information regarding the tax implications, you should speak to an experienced taxation lawyer.
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Practical Steps for Employers
While ex gratia payments are not legally required, you should still approach them with care. If you considering making an ex gratia payment, you should consider the following steps:
1. Clearly Document the Terms of the Ex Gratia Payment
For example, if you are considering a settlement agreement with an employee, clearly explain the terms of the agreement and the reason why the payment is being made. This ensures that you will be able to classify the payment as ex gratia for tax purposes and prevents any disputes between you and your employee.
2. Assess the Situation
Determine whether an ex gratia payment may be beneficial for your company by considering the circumstances. For example, in the case of a potential dispute, it may be more commercially reasonable to enter into a settlement agreement to avoid the lengthy and costly tribunal process.
3. Seek Legal Advice
Before taking any action, it is crucial that you seek legal advice. This will ensure that your payment is materially of an ex gratia nature and that you have not neglected any legal obligations. Additionally, you should seek legal advice for tax purposes.
Key Takeaways
As an employer, ex gratia payments are valuable tools that provide flexibility and goodwill in various employment situations. By understanding what they are, how they work, and the key considerations involved, you can use ex gratia payments effectively and compliantly. The key features of ex gratia payments are that they are voluntary and non-contractual and, therefore, do not have any associated employer obligations. However, there are a number of situations where ex gratia payments can be useful, including employee redundancy, settlement agreements, and to prevent potential disputes.
If you are considering making an ex gratia payment, our experienced employment lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
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