Employment termination payments, tax and injury to feelings

When you conclude a settlement agreement with a former employee or one who is leaving the organisation, can you identify part of the payment as injury to feelings for discrimination and pay it without deductions for tax and NI? No (save in exceptional circumstances), says the latest judgment of the Upper-tier tax Tribunal in Krishna Moorthy v The Commissioners for HMRC.

Whilst this is only the latest in a series of decisions on this issue, it would appear that for now identifying something as injury to feelings on severance or settlement, does not avoid tax being due.

The facts

Mr Moorthy was made redundant and received a redundancy payment of circa £10,000. He subsequently entered an Employment Tribunal claim for unfair dismissal and age discrimination, which was resolved by a settlement agreement under which he was paid a further £200,000 stated to be compensation for loss of employment. His employer paid £30,000 of the payment without deductions and taxed the rest. Mr Moorthy’s tax return claimed the full amount as being tax-free, but HMRC disagreed.

This judgment confirms (unsurprisingly) that the redundancy payment already made should have been taken into account for the £30,000 exemption, so only £20,000 of the settlement payment should have been paid without deductions.

More controversially, it also determines that, save for this £20,000, all of the payment under the settlement agreement should have been subject to tax. Whether the payment or any element of it, is identified as damages for discrimination or stated to be injury to feelings makes no difference.

The only question is whether the payment was directly or indirectly in consideration or consequence of, or otherwise in connection with, the termination of a person’s employment (a test to be applied widely) when the provision which applies the £30,000 tax-free exemption (but only that exemption) will apply.

What does this mean for me?

Some of you may in the past have specifically identified part of a settlement payment as injury to feelings and paid that without deductions for tax or NI (usually with reference to the Vento guidelines — so being less than £33,000). Following this judgment, to do so is high risk and unlikely to be accepted by HMRC.

There remain some contradictory judgments on this issue and arguments may be available, but as it stands this judgment determines that tax must be deducted where payments exceed the £30,000 exemption.

There does appear to be a disagreement between the Employment Appeal Tribunal and the Tax Tribunal about tax on discrimination awards.

We have in the past reported cases where the EAT has said awards should not be uplifted to allow for tax, as tax is not due for injury to feelings on discrimination. Those judgments are rejected by this Tax Tribunal.

That leaves some uncertainty but probably means that where a Tribunal awards over £30,000, the element over will be taxable regardless of whether it is for injury to feelings. It may mean that Employment Tribunals may increase awards to offset the tax due.

This judgment is not the end of the story. There are also two exceptions which are left by this decision which are: where the compensation is payable for discrimination before termination and not connected with it, when tax may not be due for an appropriately apportioned amount of injury to feelings; and payments made in connection with death or on account of a medical condition of an employee, such as personal injury damages (which are not discrimination injury to feelings).

Comment

Please remember that what tax must be paid on any severance payment or settlement is a complex area, and this alert focuses only on the issues raised in this case (and not for example whether the payment is a contractually due payment in lieu of notice, when it is taxable). It is only a summary of what the judgment says.

We would always recommend taking advice on any payment, we have the expertise to assist and are happy to do so.

We also expect there to be changes to the taxation of termination payments later this year, following a recent government consultation. It is entirely possible that the existing ability to pay up to £30,000 tax-free on termination will be revised or abolished, and if that happens it will have a significant impact on redundancy arrangements, severance payments, and the ability to negotiate settlements. We will keep you informed.