This case concerned whether a payment made in consequence of termination of a contract of employment was subject to the £30,000 exemption under Chapter 3, Part 6 of the Income Tax (Earnings and Pension) Act 2003 (ITEPA 2003), or whether the payment was made in pursuance of a contractual clause.

Background

The taxpayer appealed against an amendment of his self-assessment tax return for the year ended 5 April 2008. He contended that the payment made to him of £123,750 on termination of his employment was not chargeable to income tax on the first £30,000 as the payment fell within the scope of Chapter 3, Part 6 ITEPA 2003. HMRC contended that the whole payment counted as earnings as it fell within the general definition of ‘earnings’ within s. 7(3) ITEPA 2003, ‘taxable earnings’ within s. 15(2) ITEPA 2003, ‘net taxable earnings’ within s. 11 ITEPA 2003 and therefore within the charge to tax provided to tax on employment income provided by s. 9(2) ITEPA 2003.

In the Employment Agreement a clause was included which provided that in the event of dismissal for reasons other than poor performance or inexcusable conduct, the company would pay the taxpayer his basic salary and medical insurance to which he would have been entitled. Subsequent to his employment being terminated the taxpayer initiated negotiations under the remuneration package agreed within the aforementioned clause. The parties reached a Compromise Agreement which avoided the prospect of litigation. This was worth £123,750, plus the company agreed to pay legal costs which amounted to £9,582.

The company made the payments mandated under the agreement but income tax was deducted from the whole of the money paid. In his self-assessment return the taxpayer reclaimed the income tax deducted on payment of the first £30,000. As previously mentioned, HMRC have submitted that income tax is due on the whole of the £123,750.

The taxpayer submitted that the sum of £123,750 was not paid under the Employment Agreement but in fact was paid “to settle claims for wrongfully dismissing the taxpayer in breach of the Employment Agreement and for settling his claim other than for performance reasons”. He further argued that the company had suggested that the sum was paid in order to settle any dispute regarding the application of the Employment Agreement. More generally the taxpayer made the point that the company was in breach of the Employment Agreement and therefore the money paid was damages for breach of the original agreement.

HMRC submitted that the payment was in reality made under the Employment Agreement albeit in revised terms. The source of the £123,750 payment was the Employment Agreement and the aim of the Compromise Agreement was to secure partial implementation of the Agreement.

Decision

The First Tier Tribunal (FTT) dismissed the appeal. The FTT began by noting that in EMI Group Electronics Ltd. v Coldicott a payment in lieu of notice made under a contractual provision is properly to be regarded as an emolument from that employment. It further noted the decision of Chadwick LJ in Shilton v Wilmhurst in which such payments while not being remuneration for work done, neither were they compensation or damages for breach of the contract of employment. The FTT properly regarded the original agreement as being an EMI Group Electronics type payment and was therefore chargeable to income tax.

The FTT did not accept that the payment was compensation for breach of a contract of employment. The payment was not in any realistic sense damages and did not relate in any way to the economic consequences of the alleged breach.

The FTT was cognisant of the fact that if it accepted the taxpayers argument that the Compromise Agreement represented damages for breach of contract of employment, that it would then be open to any taxpayer with a similar clause in their contract of employment to accept a reduced remuneration package in order to avail of the £30,000 exemption under s. 403 ITEPA 2003. This of course would not be consistent with a purposive interpretation of the legislation.

The full text of the case is available at http://www.bailii.org/uk/cases/UKFTT/TC/2012/TC01999.pdf