Ex Gratia PaymentA voluntary payment typically made in lieu of damages or claims

Obligations and payments – these two typically go together.

I mean, would you make a payment even if you’re not obligated to pay for anything?

No, right?

Employers pay their employees because of a contractual obligation.

The employees provide services, the employer provides compensation for such services.

That’s how it usually goes with employer-employee relationships.

How about customer-vendor relationships?

A customer makes payment/s for the goods or services s/he receives, which the vendor provides.

Indeed, we typically don’t make payments unless we have to.

However, some businesses may still make payments even without a contractual or legal obligation.

Rather, they voluntarily make such payments, usually as a sign of goodwill. We refer to this type of payment as ex gratia payment.

“Ex gratia” is a Latin term that means “by favor” or “by virtue of grace”.

In this article, we will be exploring what an ex gratia payment is.

We will define it, as well as identify the specifics that make a payment an ex gratia payment.

By the end of this article, we should be able to easily distinguish an ex gratia payment from any other type of payment.

Let’s get to it!

What is an Ex Gratia Payment?

An ex gratia payment refers to a payment made typically for damages or claims but not necessarily out of any legal obligation.

You can say that it’s a voluntary payment since it’s not part of any legal liability.

The payor can make an ex gratia payment even without the admittance of liability.

Typically, it is the insurers and private businesses that make ex gratia payments, but the government may also make them.

An ex gratia payment is different from other types of payment simply because it’s not made out of any contractual or legal obligation.

Rather, the one making the payment does so by virtue of grace.

Businesses, insurers, and even the government typically make ex gratia payments as a gesture of goodwill.

Though strategically, ex gratia payments can reduce the negative publicity that arises from unfortunate events (e.g. layoffs, redundancy, accidents, collateral damage, etc.).

Specifics of an Ex Gratia Payment

Ex gratia payments aren’t legally required.

Because of this, you don’t see them that often within companies or other types of organizations.

Businesses typically only make payments out of contractual or legal obligations.

A business won’t typically pay an individual or another business without gaining anything in return.

However, a business may make ex gratia payments for strategic reasons.

For example, a business may make an ex gratia payment to a customer or supplier.

The reason for doing so is to maintain a good long-term relationship with them.

Ex gratia payments are typically made following a specific loss or damage to property.

For example, a business may give its first 100 customers free $50 gift cards.

While this action is voluntary, it doesn’t necessarily equate to an ex gratia payment since is there no specific loss that we can relate it to.

However, if a business provides credit after a service disruption, then that’s the time where there is ex gratia payment.

Insurers typically don’t make payments for insurance claims that are outside of the insurance policy.

For example, a policyholder suffers from an injury.

However, his/her insurance policy does not cover the cause of this injury.

As such, there is no legal obligation for the insurer to cover any damage claim regarding this injury (if the policyholder makes one).

Still, the insurer can voluntarily compensate for any losses caused by the injury even without the legal obligation to do so.

This makes the compensation an ex gratia payment.

Real-World Examples of Ex Gratia Payments

To better illustrate ex gratia payments, let’s have an example.

Even better, let’s have real-world examples.

Do you remember the disappearance of Flight MH370?

To refresh ourselves, Malaysian Airlines Flight 370 (MH370) was an international passenger flight.

It disappeared on March 8, 2014, during one of its flights. So where do ex gratuity payments come in this?

Well, in June 2014, Malaysia Airlines offered $50,000 to each passenger’s family.

This was before even a final compensation decision was settled.

Since the compensation isn’t to cover a legal obligation, we consider it an ex gratia payment.

The government can also make ex gratia payments.

An example of this is when the government makes payments to the family of each individual that got killed in a war or military expedition.

For a more specific example, we’ll refer to the Black Hawk Incident.

This particular incident took place in 1994.

After this incident, the US Department of Defense announced that it will make a $100,000 ex gratia payment to the family of each non-US individual who got killed because of it.

Tax Treatment of Ex Gratia Payments

In the US, ex gratia payments are typically subject to both federal and state income taxes.

This means that they receive the same tax treatment as any other type of income.

Well, on the part payee or receiver of ex gratia payments, they are technically income from nothing.

Ex gratia payments don’t arise as compensation for goods or services after all.

They are made voluntarily.

Businesses don’t make them out of any legal obligation.

Hence, it should be justifiable to treat them like any other form of income.

However, in the United Kingdom, ex gratia payments can be non-taxable so long as they don’t exceed £30,000.

Any excess will become taxable. There is the condition though that such payments should not be made for work undertaken or services rendered.

Though they are non-taxable (the first £30,000 of ex gratia payments), taxpayers still have to report them to Her Majesty’s Revenue and Customs (HMRC).

This is similar to how US citizens still have to report non-taxable income even if they are not subject to taxes.

Doing so guarantees that these taxpayers won’t have to pay any taxes or national insurance for such ex gratia payments.

Other countries may also exempt ex gratia payment up to a certain amount.

In the Philippines, separation pay is not subject to income tax.

The separation from service must be due to death, sickness or other disability,  or causes beyond the control of the employee.