Payments for injury to feelings arising on termination are taxable
Friday 12th February 2016
In the recent case of Moorthy v HMRC, Mr Moorthy was made redundant and received a statutory redundancy payment. He brought claims for unfair dismissal and age discrimination, focusing on his selection for redundancy; no pre-selection discrimination was alleged.
The dispute was resolved with a compromise agreement. Mr Moorthy received a settlement payment of £200,000 as an ex gratia sum “by way of compensation for loss of office and employment”.
Mr Moorthy argued that the entire payment was tax exempt as compensation for the injury to feelings he suffered as a result of age discrimination, seeking to rely on section 406 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”), which permits tax free payments made on account of injury, death or disability. HMRC disagreed and applied the usual £30,000 tax free amount allowed for termination payments under section 403 of ITEPA, allowing as a concession a further £30,000 to be tax exempt as damages for age discrimination. The remaining £140,000 was taxable under section 401 of ITEPA.
Mr Moorthy unsuccessfully appealed to the First Tier Tribunal, which found that he could only receive a total of £30,000 tax free, inclusive of the statutory redundancy payment. Mr Moorthy appealed and the Upper Tribunal has held that:
- The entire payment was in connection with the termination of Mr Moorthy’s employment and therefore, subject to any exceptions, was taxable as earnings under section 401 of ITEPA;
- The fact the payment exceeded the statutory maximum for unfair dismissal did not mean the remainder was unconnected to the termination of his employment; and
- Mr Moorthy could not rely on the exception in section 406 of ITEPA, because the “injury” contemplated by that provision referred to a medical condition which led to the termination of employment or a change in duties; it is not a catch-all provision for non-pecuniary awards.
Compensation for discrimination which occurs during employment but before termination is not considered earnings and is therefore not taxable. Therefore, depending on the facts of a particular situation, it may still be possible to allocate a portion of a settlement payment as compensation for injury to feelings arising from discriminatory treatment which occurred during employment. However, this will require careful consideration and the potential apportionment of compensation.
All information in this update is intended for general guidance only and is not intended to be comprehensive, or to provide legal advice.