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Myth-busting: Employers can always pay the first £30,000 of any severance payment tax free

Employment laws generate a lot of comment. Hardly a day goes by without the media reporting scare stories about the employment rights of UK employees, which are depicted as being anti competitive, unduly restrictive and in many cases overly generous.

Each month, we are exposing some of the most common employment law myths and explaining the reality behind them. We are not pretending that employment law is easy – it isn’t, but generally it should not be difficult to get the basics right.

This month we look at whether the first £30,000 of any severance payment can be paid tax free.


Employers can always pay the first £30,000 of any severance payment tax free.


The general position is that it is only the first £30,000 of any non-contractual payment which can be paid free of tax. Contractual payments made on termination of employment are subject to tax, even if they are expressed to be paid as compensation for the loss of employment or as an 'ex gratia' payment.

If your employee’s contract of employment includes a payment in lieu of notice clause (“PILON”) and you decide to exercise this on termination, the notice payment is subject to tax, irrespective of how much is being paid.

Even if your employee does not have a contractual PILON clause, a payment made in lieu of notice may still be taxable if PILON’s are routinely made and can be said to be an ‘automatic response to termination’. Payments that are individually negotiated in an organisation that does not routinely make PILON’s are unlikely to be at risk of being deemed ‘auto-PILON’s’.

Payments made to compensate an employee for the loss of contractual benefits during their notice period, such as the use of a company car, health insurance etc are also taxable.

The £30,000 exemption is only available in respect of certain non-contractual payments including payment of damages, compensation for unfair dismissal, payments of statutory and non-statutory redundancy payments.

A handy table is set out below:

Sums the employee is contractually entitled to which relate to past or future service: Generally, taxable in full
– Salary, garden leave payments 
– Taxable in full
– Contractual bonus or commission
– Taxable in full
– Contractual PILONs
– Taxable in full
– Customary or automatic PILONs
– Taxable in full
– Consideration for entering into restrictive covenants
– Taxable in full
Non contractual payments made as a result of termination and redundancy Taxable, but cumulatively, £30,000 tax free allowance available
– Damages for wrongful dismissal and payment on account of damages
– £30,000 tax free allowance available
– Compensation for discrimination made in connection with the termination to compensate for financial loss
– £30,000 tax free allowance available
– Payments of statutory and non-statutory redundancy
– £30,000 tax free allowance available
– Non-contractual benefits in kind provided on termination
– £30,000 tax free allowance available
Payments where termination results from a disability or from a discrimination claim not connected to the termination Tax free (without limit)
Employer contributions to registered pension schemes May be made tax free subject to the annual allowance and lifetime allowances.

Have you missed any of our other myth busters?

So far we have tackled the following myths:

1. In order to dismiss an employee, you must follow a particular procedure and if you do so, you can safely dismiss.
2. It’s not possible to retire employees anymore.
3. You can’t make a woman on maternity leave redundant.
4. Parents have the right to work part time.
5. An employer has to accept an employee’s resignation before it will take effect.
6. Employers must provide exiting staff with a reference.
7. Employers do not need to do pre-employment immigration checks on British or EU recruits.
8. You can vary an employment contract by giving notice.
9. An employee’s entitlement to notice is based on how often they are paid.
10. Employers have to accommodate all religious sensibilities and beliefs.