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    TaxKilnUK tax guidance

    Redundancy + termination → Injury + disability exemption (s.406)

    Injury + Disability Termination Exemption — ITEPA 2003 s.406 (No £30k Cap)

    ITEPA 2003 s.406 provides a full income tax exemption — with no £30,000 cap — for termination payments and benefits received on account of injury to, or disability of, an employee. Unlike the s.401 / £30k cap, s.406 is unlimited. But HMRC scrutinises it heavily: the exemption requires (a) a genuine injury or disability of the employee; (b) a real connection between that condition and the termination; and (c) contemporaneous medical evidence. 'Stress' on its own usually does not qualify unless it amounts to a recognised psychiatric illness with documented diagnosis and a clear causal link to the termination. The cold-pitch market 'stress-claim conversion specialist £2k+' is largely fraudulent — characterisation is a fact-and-evidence question, not a structuring choice.

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    In plain English

    s.406 ITEPA gives a much broader exemption than the £30,000 cap — payments received because of a genuine workplace injury or a disability that ended your employment are fully exempt from income tax, with no upper limit. Examples that clearly qualify: • A construction worker who suffers a serious back injury at work and accepts a payment to leave because they can no longer perform the role. • An office worker diagnosed with a long-term disability that materially affects their ability to do the job, who accepts ill-health retirement compensation. • An employee with diagnosed PTSD or major depressive disorder (with consultant psychiatrist evidence) who leaves under a settlement that genuinely compensates for the impact of the workplace condition. What does NOT qualify just by labelling: • 'Stress' without a recognised diagnosis — HMRC's position is that ordinary work-related stress is not a disability for s.406 purposes. • A settlement of an ordinary redundancy with a 'stress' line added to absorb the slice above £30k — this is the pattern HMRC enquires hardest on. • An injury that occurred years before termination and was unrelated to the leaving event. Documentation is everything: GP or consultant letters; occupational health reports; sickness absence records contemporaneous with the condition; medical opinion confirming the causal link between condition and termination.

    How it works

    The three-element test

    For s.406 to apply: (1) the employee has an injury or disability; (2) the payment / benefit is received on account of that injury or disability; (3) there is a genuine causal link between the condition and the termination. HMRC will look at medical records, occupational health reports, sickness absence patterns, and the settlement-agreement drafting to assess each element.

    What 'disability' means

    Generally aligned with the Equality Act 2010 concept — a physical or mental impairment with substantial and long-term adverse effect on ability to carry out normal day-to-day activities. Specifically includes recognised psychiatric conditions diagnosed by a qualified clinician.

    Stress as a borderline category

    Generic 'work stress' without a clinical diagnosis is typically NOT a disability for s.406 purposes. Where stress has progressed to recognised conditions — clinical depression, generalised anxiety disorder, PTSD — with consultant evidence and a clear connection to the workplace, s.406 may apply. HMRC's enquiry rate on stress-characterised s.406 use is high.

    Documentation requirements

    Best practice: contemporaneous medical evidence (GP letters, consultant reports, OH assessments) predating the settlement; a specific recital in the settlement agreement identifying the s.406 amount and the underlying condition; an option for the employer to make the s.406 payment conditional on receipt of an independent medical opinion confirming the connection.

    Mixed settlements

    A settlement can have a s.406 slice and a s.401 slice. Example: a £100k package might be split £40k under s.406 (injury / disability compensation, fully exempt with medical evidence) + £30k under s.401 (ordinary ex-gratia, within £30k cap) + £30k taxable balance. Split-line drafting is essential.

    Who this applies to + key conditions

    Statute + manual references

    Primary: ITEPA 2003 section 406 — exemption from income tax for payments and benefits received on account of injury or disability.

    Related: ITEPA 2003 s.401-416 — surrounding termination payment regime; Equality Act 2010 — definition of disability (long-term physical or mental impairment with substantial adverse effect)

    HMRC manual: EIM13610 onwards — injury / disability exemption; EIM13615 (disability evidence); EIM13620 (psychological injury)

    Common mistakes + traps

    Worked example

    Lena, age 52, customer-service team leader, diagnosed with severe clinical depression after 18 months of escalating workplace bullying; clinical psychiatrist diagnosis Sept 2024; 9 months sickness absence; settled exit February 2026

    Settlement: £25,000 ex-gratia compensation for loss of office (within s.401); £35,000 in connection with Lena's diagnosed condition under s.406; £4,000 holiday pay; total £64,000.

    1. Step 1 — Documentation: Lena's psychiatrist's diagnosis letter (Sept 2024); GP records of sickness absence (June 2024 onwards); occupational health report (Nov 2024); ACAS-conciliated grievance correspondence (Jan-Feb 2026) referencing health impact.
    2. Step 2 — Settlement-agreement drafting: separate recital identifies the £35,000 as 'in respect of the Employee's diagnosed condition referred to in the medical reports listed at Schedule 2, in connection with the termination of employment'.
    3. Step 3 — Tax: £4,000 holiday pay — PAYE + NIC. £25,000 ex-gratia — within s.401 / £30k cap, tax-free. £35,000 under s.406 — full exemption, tax-free, no NIC.
    4. Step 4 — HMRC enquiry risk: documentation supports the s.406 characterisation. If HMRC challenges, Lena's medical evidence pack is contemporaneous and clearly causal.

    Outcome: Lena receives £60,000 tax-free + £4,000 holiday taxed normally. Defensible against HMRC enquiry because of contemporaneous medical evidence and explicit settlement recital.

    How this connects to the rest of the framework

    £30k exemption mechanics →

    s.406 sits outside the £30k cap entirely — and can be combined with s.401 slices in the same settlement.

    Settlement agreements →

    Mixed s.406 + s.401 settlements need explicit line-item drafting.

    Scenarios — 8 cases →

    Stress-related termination scenario shows medical-evidence threshold in practice.

    Frequently asked questions

    What happens if I miss the Self Assessment deadline?+
    The Self Assessment deadline is 31 January (online filing) for the previous tax year. Miss it and HMRC apply an automatic £100 penalty. Beyond that: £10 per day from 3 months late (capped at £900), 5% of tax due at 6 months late, and another 5% at 12 months late, under Schedule 55 of the Taxes Management Act 1970. If you have a genuine reason (serious illness, bereavement, technical issue with HMRC's systems) you can appeal with evidence; HMRC accepts reasonable excuse appeals in most genuine cases.
    Do I need an accountant or can I file Self Assessment myself?+
    Legally you can file Self Assessment yourself via gov.uk for free, most simple sole-trader returns (single income source, basic expenses) are realistic to self-file. An accountant adds real value when: your trading profit is above £40,000 (extraction-strategy decisions matter), you have multiple income streams (PAYE + self-employment + property + dividends), you've crossed the £90,000 VAT threshold, you're considering incorporation, or you have an HMRC enquiry. Expect to pay £400-£1,500/year for a typical sole-trader accountant; the cost is itself a deductible expense.
    How do payments on account work?+
    When your Self Assessment tax bill exceeds £1,000 for the first time, HMRC requires payments on account toward NEXT year's tax. Half the current bill is due 31 January (alongside the current bill); the other half is due 31 July. So your first January after crossing the threshold can hit with a double-bill: last year's balance + first payment on account. Adjust via Form SA303 if you expect next year's income to drop substantially. Payments on account don't apply if more than 80% of your tax is collected via PAYE.
    Can I use s.406 retroactively for an old injury?+
    Only if the injury or disability has a genuine causal link to the current termination. An old injury that played no role in the leaving event does not qualify.
    Does s.406 apply to dependants' payments after death in service?+
    Different exemption — see ITEPA s.405 and PTM regime for lump-sum death benefits, not s.406.
    Is workplace stress alone enough?+
    Usually not. HMRC accepts recognised psychiatric conditions with clinical diagnosis. Ordinary 'stress' descriptions in HR records without a diagnosis fall short.
    Does s.406 attract NIC?+
    No — fully exempt from employee and employer NIC where the income tax exemption applies.

    Free + regulated-body resources

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