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 Court of Appeal held that payments for injury to feelings in the context of an age discrimination claim were exempt from tax but that any awards should be modest.
After he was made redundant, Mr Moorthy claimed unfair dismissal and age discrimination. As part of a settlement agreement, the company agreed to make him an ex gratia payment of £200,000 “for loss of office and employment”. The company 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. It did not stipulate that part of the payment was to compensate Mr Moorthy for injury to feelings.
When he subsequently completed his tax return Mr Moorthy claimed that the whole payment was not taxable because of the exemption under section 406(b) ITEPA which, he argued, included injury to feelings which he had sustained in the context of his age discrimination claim. HMRC contended, however, that it was taxable as a termination payment under section 401 as the reference in section 406(b) was to personal injury only.
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”.
Decisions of First-Tier and Upper Tribunals
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 (weekly LELR 406).
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. However, as this payment was made in connection with the termination of his employment, it fell under section 401 (weekly LELR 461).
Decision of Court of Appeal
The Court of Appeal agreed that the entirety of the payment fell within section 401, as Mr Moorthy received it in connection with the termination of his employment. Indeed, the payment was described in the settlement agreement as representing “compensation for loss of office and employment”.
However, it then went on to hold that a payment of damages for injury to feelings in the context of an age discrimination claim fell within the natural language of section 406. As there was no definition of the word “injury”, there was therefore no reason why it should not be given its ordinary meaning. The injury sustained by Mr Moorthy was an injury to his feelings rather than to his person, but as a matter of ordinary language it was still an injury. Apart from anything else, if Mr Moorthy had been paid damages for a personal injury sustained by him at his workplace, or damages for defamation by his employer, he would not have had to pay income tax on it.
The Court therefore concluded that damages for injured feelings in the context of an age discrimination claim fell within the exemption in section 406. However, as the guidelines showed that any awards should be modest in size, it held that only £30,000 should be exempted.