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    TaxKilnUK tax guidance
    TaxKilnUK tax guidance

    Redundancy + termination → Restrictive covenants

    Restrictive Covenants on Termination — Hasted v Horner (1995) 67 TC 439

    Payments made in consideration of restrictive covenants — non-compete, non-solicit, non-deal, confidentiality clauses backed by consideration — are fully taxable as ordinary employment income and CANNOT fall within the £30,000 s.401 exemption. HMRC's authority is in EIM12977+ and EIM13630; the leading case is Hasted v Horner (1995) 67 TC 439 (Vinelott J, ChD). The practical risk in settlement-agreement drafting is that ambiguous or broadly drafted restrictive covenant consideration can re-characterise what 'feels' ex-gratia into the fully-taxable bucket. Best practice: allocate restrictive covenant consideration on its own clearly-identified line and tax it in full, so the remaining compensation for loss of office is unambiguously within s.401.

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    In plain English

    Restrictive covenants are post-termination contractual obligations: don't compete with the employer, don't poach clients, don't poach staff, keep confidential information confidential. Where the leaver receives a payment specifically in consideration of accepting or reaffirming such covenants, that payment is treated as ordinary employment income and taxed in full — even though the leaver is no longer working for the employer. The leading authority is Hasted v Horner (1995) 67 TC 439, decided by Vinelott J in the Chancery Division. The case established that restrictive covenant consideration cannot benefit from termination-payment treatment. The current statutory hook is ITEPA 2003 s.225 (consideration for restrictive undertakings), reflected in HMRC's Employment Income Manual at EIM12977 onwards and EIM13630. The practical trap in settlement-agreement drafting: if the agreement says 'in consideration of the covenants set out in clause X and the release of all claims, the Employer shall pay £30,000', HMRC may argue that some or all of that £30,000 is restrictive covenant consideration — fully taxable, no £30k exemption. The fix is to split the consideration explicitly: 'In consideration of the covenants in clause X, £1,000 (taxable in full). In compensation for loss of office, £29,000 (within ITEPA s.401).' The £1,000 absorbs the restrictive covenant tax; the £29,000 sits cleanly within the £30k exemption. This is one area where a qualified employment lawyer + an accountant earn their fees — not the £1,500 'specialist' tier.

    How it works

    Why the £30k exemption doesn't apply

    ITEPA s.401 covers payments 'received in connection with the termination of employment'. Restrictive covenant payments are received in connection with FUTURE obligations of the leaver, not in connection with the termination itself. Hasted v Horner confirmed this characterisation — and the practical effect is that s.225 ITEPA charges them in full.

    The drafting fix

    Split the consideration explicitly in the settlement: a clear, separate line item for restrictive covenant consideration (taxed in full at the time of payment via PAYE); a clear, separate line item for compensation for loss of office (within s.401 / £30k). HMRC will respect a properly-drafted split.

    Reasonableness + nominal consideration

    There is no rule that restrictive covenant consideration must be 'substantial' to be valid as a tax matter — £1 will do for tax characterisation purposes, although under contract law a more substantial consideration may be required for enforceability of broad covenants. Practitioners often allocate £500-£1,000 to restrictive covenants and route the rest as ex-gratia.

    Confidentiality clauses

    Ordinary confidentiality clauses (continuing the existing duty of confidentiality) do not, by themselves, require separate consideration. But where the agreement explicitly pays for confidentiality (e.g. an NDA premium), HMRC may characterise that consideration as restrictive covenant payment — fully taxable.

    Class 1 NIC + employer NIC

    Restrictive covenant payments attract full Class 1 employee NIC and employer NIC, in addition to PAYE income tax. This is in contrast to s.401 payments, where the £30k+ slice attracts only employer Class 1A NIC from April 2020.

    Who this applies to + key conditions

    Statute + manual references

    Primary: ITEPA 2003 s.225 — consideration for restrictive undertakings is chargeable as employment income.

    Related: ITEPA 2003 s.401-416 — termination payment regime that does NOT apply to restrictive covenant payments; ITEPA 2003 s.6 — general charge on employment income

    HMRC manual: EIM12977+ (restrictive undertakings); EIM13630 (interaction with termination payments + Hasted v Horner)

    Case law: Hasted v Horner (1995) 67 TC 439 (Vinelott J, ChD) — restrictive covenant payment characterisation; leading authority

    Common mistakes + traps

    Worked example

    Priya, senior executive £150,000 salary, leaving with broad non-compete + non-solicit covenants

    Settlement: £40,000 PILON (PENP); £30,000 ex-gratia compensation for loss of office; £20,000 'in consideration of the restrictive covenants in clauses 8-11'.

    1. Step 1 — PILON £40,000: ordinary income, PAYE + NIC.
    2. Step 2 — Restrictive covenant £20,000: ordinary income per ITEPA s.225 and Hasted v Horner; PAYE + Class 1 employee NIC + employer NIC.
    3. Step 3 — Ex-gratia £30,000: within s.401, fully covered by £30k exemption — tax-free, no NIC.
    4. Step 4 — Compare to a poorly-drafted alternative where the £20,000 was bundled into 'compensation' (£50,000 total). HMRC would likely characterise £20,000 of that as restrictive covenant — same tax outcome but with risk of dispute, interest, and penalties on the employer for under-deduction at source.

    Outcome: Priya's £30,000 ex-gratia is preserved tax-free; £60,000 of taxable income runs through PAYE; the split-line drafting is unambiguous to HMRC and avoids enquiry risk.

    How this connects to the rest of the framework

    Settlement agreements →

    Settlement-agreement drafting must split restrictive covenant consideration explicitly to preserve the £30k exemption on the ex-gratia slice.

    £30k exemption mechanics →

    Restrictive covenant payments are an explicit exclusion from the £30k cap.

    Scenarios — 8 cases →

    Senior executive scenarios commonly feature substantial restrictive covenant slices alongside ex-gratia compensation.

    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 avoid tax by allocating zero to restrictive covenants?+
    If covenants are genuinely already in the contract and no new consideration is being paid, there is no separate charge. But if you sign new or reaffirmed covenants and the settlement is silent on allocation, HMRC may impute one.
    Are confidentiality NDAs always taxable?+
    Only where consideration is explicitly paid FOR the NDA. Standard continuing confidentiality duties don't trigger a charge on their own.
    Does the case Hasted v Horner still apply?+
    Yes — it remains the leading authority and is cited in current HMRC manual entries (EIM13630).
    Do restrictive covenants attract Class 1A NIC?+
    No — they attract full Class 1 (employer + employee) NIC because they are ordinary employment income. Class 1A applies only to s.401 termination payments above £30,000 (from April 2020).

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