Being told not to return to work can make garden leave feel different from ordinary employment. Tax-wise, however, the answer to “are garden leave payments taxable” is usually straightforward: yes. If you remain employed and continue to receive your normal salary during garden leave, those payments are normally taxed through PAYE and subject to National Insurance in the usual way.
That does not mean every payment made around the same time will be treated identically. A settlement agreement may include notice pay, holiday pay, bonus, benefits and a termination payment. Each element needs to be identified clearly before you decide whether the proposed figures are fair.
What garden leave means for tax
Garden leave is a period during your notice period when you remain employed but are not required to carry out your normal duties. Your contract may require you to be available, keep information confidential, avoid working elsewhere and comply with restrictions on contacting clients or colleagues.
The key point is that your employment has not yet ended. You are still receiving pay under your contract, rather than compensation for the loss of your job. HMRC will generally treat salary paid during this period as employment income.
Your employer should deduct income tax and employee National Insurance contributions before paying you. The employer will also usually account for its own National Insurance contributions. Your payslip should show the deductions in the same way it did before garden leave started.
For many employees, this is the simplest arrangement. You continue to receive monthly pay, pension contributions may continue, and benefits such as private medical insurance or a company car may remain available if your contract or agreement says so. The fact that you are at home does not make the pay tax-free.
Why garden leave is different from a tax-free termination payment
The tax-free treatment often associated with settlement agreements can cause understandable confusion. A genuine termination payment may, in some circumstances, be paid tax-free up to £30,000. But that exemption does not apply to ordinary salary, contractual notice pay or payments made for time during which you remain employed.
Garden leave pay is normally contractual remuneration. It therefore sits outside the £30,000 exemption.
The same principle applies where an employer calls an amount “compensation” but it is really payment for notice, salary, commission already earned or holiday accrued. Labels are not decisive. What matters is the legal and practical reason for the payment.
Where notice is not worked, tax treatment can also be affected by the post-employment notice pay rules, often referred to as PENP. These rules can bring part of a termination payment into tax where it represents basic pay for unworked notice. Garden leave usually avoids that particular issue because notice is being worked in the sense that the employment continues, even if duties do not.
Payments commonly included alongside garden leave
A proposed exit package can contain several separate sums. It is worth asking for a clear written breakdown, particularly if the total figure is presented as one headline amount. The following items are commonly taxed as earnings:
- salary paid during garden leave;
- pay in lieu of notice, where payable under the contract or caught by PENP rules;
- accrued but untaken holiday pay;
- bonuses, commission and other incentives that have been earned or are contractually due; and
- taxable benefits or cash allowances continuing during employment.
A discretionary bonus needs closer attention. Your contract may say that you must be actively employed, not under notice, or not on garden leave on the payment date. Alternatively, it may give the employer a broad discretion. The position depends on the wording, established practice and the circumstances of your departure. It should not simply be assumed that no bonus is payable.
Pension contributions also deserve specific attention. If you are on garden leave, your contractual pension arrangements may continue until the termination date. If a settlement agreement proposes that contributions stop earlier, or offers a cash alternative, obtain advice on both the value and tax consequences.
How a settlement agreement should deal with tax
A carefully drafted settlement agreement should separate the payments due to you and explain the intended tax treatment. It should state the amount of salary or garden leave pay, notice pay, holiday pay, any bonus or commission, and any payment described as compensation for termination.
Most agreements contain a tax indemnity. This is a clause saying that if HMRC later seeks tax, National Insurance, interest or penalties on sums paid to you, you may have to reimburse the employer. Such clauses are common, but they should not be treated as a reason to accept an unclear allocation of payments.
You should check that the agreement does not attempt to describe taxable earnings as tax-free compensation simply to make the offer appear more generous. If HMRC takes a different view later, the risk may be passed back to you through the indemnity. Clear drafting and a realistic tax analysis protect both sides.
There may also be a clause allowing the employer to make deductions required by law. That is standard. It does not give the employer a free hand to deduct sums without explanation. Ask for an estimated net payment schedule where possible, especially if you need to plan rent, mortgage payments or the period before your next role begins.
Timing can affect your net position
Garden leave pay is usually processed through the normal payroll cycle. If a large bonus, holiday payment or taxable benefit is paid in the same month, PAYE may initially make the deduction look higher than expected. This does not always mean too much tax has been paid overall, but it can affect cash flow.
Your tax code, other employment income and the date your new job begins can all alter the final position. If you leave one employer and start another during the same tax year, make sure your P45 is provided and give it to your new employer promptly. This helps the correct code be applied.
The tax year end can matter too. An exit in late March rather than early April may affect when income falls for tax purposes, although it is rarely sensible to make a major employment decision on tax timing alone. The strength of the settlement terms, your notice rights and the security of your next step normally matter more.
A practical check before you sign
Before accepting a settlement agreement that includes garden leave, compare the proposal against your employment contract and recent payslips. Check the start and end dates of garden leave, your gross salary, pension contributions, benefits, bonus provisions and accrued holiday.
Then look closely at the payment schedule. Does it distinguish salary paid up to termination from a genuine termination award? Is tax being deducted from the sums that are clearly taxable? Does the agreement explain what happens if you secure another role before garden leave ends? Some contracts allow an employer to reduce or offset payments if you start work elsewhere, while others do not.
You should also consider the non-financial terms. Garden leave can affect when you may join a competitor, communicate with customers or announce your departure. A settlement agreement may include new or extended restrictions, confidentiality obligations and agreed reference wording. A higher headline payment may not be a fair trade if the restrictions are wider than your contract allows.
When independent advice is particularly useful
Independent legal advice is required for a settlement agreement to validly waive statutory employment claims. The adviser’s role is not limited to witnessing your signature. They should explain what claims you are giving up, whether the financial terms reflect your rights, and whether tax wording or restrictive covenants create avoidable risk.
Advice is especially valuable where garden leave runs for several months, bonus or commission is disputed, the agreement combines several types of payment, or the employer has offered a figure said to be tax-free without a clear breakdown. Senior employees may also need to consider share schemes, deferred incentives and director obligations.
Arcos Settlement Agreements provides clear, independent advice on the terms as a whole, including how garden leave and tax clauses fit within the proposed exit. If a separate accountant’s input is needed for complex personal tax planning, that can be identified early rather than after the agreement is signed.
Garden leave should give you breathing space, not leave you guessing about your income. Ask for the figures in writing, check what remains payable until your employment ends, and make sure the agreement reflects the real nature of every payment before you commit.