The law states that the first £30,000 of any payment made on termination of employment is exempt from tax, but what about payments made for injury to feelings? In Moorthy v HM Revenue and Customs (HMRC) the Upper Tax Tribunal held that if the payment is made on termination of employment, then the whole payment (minus £30,000) is liable to tax.
Shortly after being made redundant from his job, Mr Moorthy received a statutory redundancy payment just short of £11,000 from which no tax was deducted in the 2009-2010 tax year. His subsequent claim for unfair dismissal and age discrimination was settled as part of a settlement agreement under which the company agreed to make him an ex gratia payment of £200,000 “for loss of office and employment”.
His former employer treated the first £30,000 of the payment as exempt from tax by virtue of section 403 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) and deducted basic rate income tax from the balance. Mr Moorthy completed his self-assessment tax return for 2010-11 on the basis that the settlement amount was tax-free. However, HMRC held that it was taxable as a termination payment under section 401 ITEPA. In August 2013, it issued a closure notice amending Mr Moorthy’s self-assessment return for 2010-11 to include an additional £140,023 as taxable income.
Section 401 ITEPA “applies to payments and other benefits which are received directly or indirectly … in connection with … the termination of a person’s employment”. Section 403 states that a payment counts as employment income to the extent that it exceeds the £30,000 threshold. Section 406(b) exempts payments or benefits “on account of injury to … an employee”.
Decision of First-Tier Tribunal
The First-Tier Tribunal held that the total payment of £200,000 fell within section 401 as there was a clear connection between the payment and the termination of Mr Moorthy’s employment. As such, it was irrelevant whether the settlement payment was also made to compensate Mr Moorthy for discrimination, unfair dismissal, injury to feelings, redundancy and/or financial loss. As he had already received almost £11,000 tax free in the previous tax year, the £30,000 exemption allowed by section 403 had to be reduced accordingly.
Mr Moorthy appealed on the basis that the settlement sum was not liable for tax because of the exemption under section 406(b) which, he argued, included injury to feelings.
Decision of Upper Tax Tribunal
The Upper Tribunal held that there was nothing in the terms of section 401 to exclude non-pecuniary awards, such as damages for injury to feelings, from its scope. The only question was whether the payment was made directly or indirectly in connection with the termination of Mr Moorthy’s employment. Even though the amount of compensation exceeded the maximum award for unfair dismissal, that did not alter the fact that it was made in connection with the termination of his employment.
It was also clear that section 406(b) was not a general exemption for payments on account of “injury” to an employee. Instead the term had to be interpreted as applying to injuries which had led to the termination of employment or to a change in duties or level of earnings. It therefore dismissed the appeal.
This case is important in clarifying the position with regard to payments deemed as received on the termination of the employee’s employment. Importantly however the Upper Tribunal accepted the apparent “anomalous distinction” between payments of compensation for discrimination before termination, which in Mr A v HMRC were held not to be taxable as earnings under section 62 ITEPA. This distinction may sometimes require the apportionment of the compensation between events which occurred before and after termination.