Termination payment or employment earnings?

The question brought before the First Tier Tribunal was whether a payment made to the taxpayer in connection with the termination of her employment constituted “earnings” within the meaning of section 63 Income Tax Act 2003 or within section 401 Income Tax Act 2003.

The taxpayer commenced employment with Bristol-Myers Squibb Pharmaceuticals Limited (BMS) in October 1996. The terms of the taxpayer's employment entitled her to not less than one month's notice in writing up to a maximum of 12 weeks with four years service or more. The taxpayer was promoted within BMS and her notice entitlement was increased to three months, but the terms of her employment were never updated to reflect this fact.

Due to restructuring within BMS in 2003, the taxpayer was required to take on responsibility for data management. The taxpayer took the view that the changes made to her employment were such that the job for which she had accepted employment no longer existed. She notified BMS that she regarded herself as been constructively dismissed and as her notice period was three months she expected to receive three months' salary in lieu of notice. BMS did not accept that she was dismissed but rather considered that she had resigned. As such, unless the she worked her three months' notice, she was not entitled to any compensation or benefits during this time.

BMS did offer the taxpayer two payment options as a goodwill gesture and the taxpayer accepted the three months' salary lump sum payment. However, she declared on her self-assessment income tax return that the payment was not chargeable to income tax. HMRC opened an enquiry into that self-assessment tax return.

HMRC maintained that the taxpayer resigned from her employment with BMS and therefore the payment made was taxable employment income made under the terms of her employment contract. Alternatively, HMRC contended that the payment was made in agreement to terminate the employment without notice. The taxpayer claimed that the payment was made either on an ex gratia basis or to settle her claim for constructive dismissal.

Based on the evidence presented, the Court held that the taxpayer had been constructively dismissed and that there was no term implied in her employment agreement by custom and practice giving her right to a payment in lieu of notice on the termination of her employment. The payment was made either on an ex gratia basis or to settle the taxpayer's common law claim for constructive dismissal. In either event, the Court found that the payment fell with section 401(1) and therefore was exempt from income tax as it fell within the relief available under section 403, being less than £30,000.

The full judgment is available at http://www.financeandtaxtribunals.gov.uk/judgmentfiles/j4641/TC00278.doc