A Ms. O’Farrell worked for Publicis Consultants UK Ltd. Her contract provided for three months’ notice.  She was made redundant in May 2009 and was provided with statutory redundancy pay and holiday pay. Her dismissal letter also said that she would receive an ex-gratia payment equivalent to three months’ salary (£20,625) free of Tax and NI deductions.

She successfully claimed at an employment tribunal that the company was in breach of contract by failing to pay her notice pay.  The employer appealed to the EAT on the basis that the three months’ “ex-gratia” was in fact the 3 months’ notice pay provided for by her contract. The employer has lost (Publicis Consultants Ltd v O’Farrell, EAT on 27 May 2011).

The EAT judge agreed with the original tribunal. The issue to be determined was, as a matter of law, how should the dismissal letter be construed. Did it mean ‘we are hereby paying you for your period of notice’ or did it  mean ‘we are hereby paying you a sum other than the monies to which you  would be entitled by way of pay in lieu of notice’?

Taking the words used as a starting point, to an ordinary reader the letter meant that three payments were to be made. The company was legally obliged to pay two of them, the third was a payment “made freely and not under obligation“. The tribunal’s interpretation of the words ex-gratia was correct.  Nothing in the language used in the dismissal letter suggested that the ex-gratia payment was a payment for a period of notice and no background information put forward changed that position.

How this case came about is unclear.  As is well known, the first £30,000 of a genuinely ex gratia payment made to a departing employee is free of tax – but is liable to tax in the ordinary way if the employee has a contractual right to it. It may be, although this is pure conjecture, that the employer in this case was trying to help an employee get a sum free of tax which would normally be subject to tax. Whether or not that happened here, the message for employers is to take care: trying to get around HMRC rules for the benefit of a valued ex-employee by dressing up pay in lieu of notice as an “ex gratia” payment will not work. Whether that is what happened here or not, this case demonstrates that an attempt to do so could be very costly for the employer.