This month’s Chartered Accountants Tax Case Digest looks at an Upper Tribunal (“UT”) case which examined whether a payment made under a compromise agreement signed after termination of employment was a payment under section 401 of the Income Tax (Earnings and Pensions) (ITEPA) Act 2003 and thus chargeable to income tax. The case dealt with compensation for injury to feelings arising from discriminatory treatment and examined whether this was also exempt under Section 406(b).

In its decision, the UT highlighted the deliberately broad drafting of the legislation. If a payment satisfies the criteria of being “received directly or indirectly in consideration, or in consequence of, or otherwise in connection with” the termination of employment, it does not matter if it has another purpose, as was the case here. This could bring many different types of payments in connection with termination of employment within the charge to income tax.

Background

The case concerned an appeal which examined if payment to settle a claim for unfair dismissal and age discrimination following termination of employment by reason of redundancy is employment income under sections 401 and 403 of the Income Tax (Earnings and Pensions) Act 2003 (‘ITEPA’) and is thus chargeable to income tax as a result.

The taxpayer was made redundant by his employer, Jacobs Engineering (UK) Limited (‘Jacobs’) and received statutory redundancy pay totalling £10,640 in 2009–10 from which no tax was deducted.

The taxpayer subsequently brought proceedings claiming unfair dismissal and age discrimination. Following mediation, an agreement (‘the compromise agreement’) was reached under which Jacobs agreed to pay the taxpayer “an ex gratia sum of £200,000 by way of compensation for loss of office and employment” (‘the settlement amount’).

Jacobs treated £30,000 of the settlement amount as exempt from tax by virtue of section 403 ITEPA and deducted income tax at the basic rate from the balance. The taxpayer completed his self-assessment tax return for 2010–11 on the basis that the settlement amount was tax free.

HMRC did not agree and, in 2013, issued a closure notice amending the taxpayer’s self-assessment return to include an additional £140,023 as taxable income. The taxpayer’s appeal was brought before the First-tier Tribunal (‘the FTT’).

The FTT found that:

1. the settlement amount of £200,000 fell within section 401 ITEPA;
2. taking into account a previous statutory redundancy payment of £10,640 made in 2009–10, the £30,000 exemption allowed by section 403 ITEPA was reduced to £19,360; and
3. the FTT had no jurisdiction to allow a further relief of £30,000 that was treated by HMRC, as a concession, as damages for age discrimination and outside the charge to income tax.

The taxpayer appealed against the FTT decision.

Decision

The appeal raised two key issues.

Issue 1 – whether the settlement amount was a payment in connection with the termination of employment within section 401 ITEPA to be treated, to the extent that it exceeds the £30,000 threshold in section 403, as employment income chargeable to income tax.

Issue 2 – if the settlement amount falls within the scope of section 401, whether it is taken out of the charge to tax by section 406(b) ITEPA as a payment or benefit “on account of injury to … an employee”, namely injury to feelings

Issue 1

There is nothing in the terms of section 401, read alone or together with the other sections which excludes non-pecuniary awards, such as damages for injury to feelings, from the scope of the section. Section 401 is not restricted to payments made under a contractual entitlement or to payments made at the time of termination. The only question that determines whether section 401 applies is whether the payment was directly or indirectly in consideration or in consequence of, or otherwise in connection with the termination of a person’s employment.

The UT agreed that the FTT was correct to disregard the possible reasons for the payment, such as the desire to settle the taxpayer’s claim for unfair dismissal and injury to feelings or protect Jacobs’ reputation, as irrelevant.

Once it was established on the facts that the settlement payment was, directly or indirectly, in consideration or in consequence of, or otherwise in connection with the termination of employment then it is within section 401.

Issue 2

The UT then examined the exemption in Section 406(b). It declined to follow previous decisions because these were considered wrongly decided in so far as they held that “injury” in section 406 ITEPA includes injury to feelings.

The leading case to have considered the scope of section 406 is Horner v Hasted (Inspector of Taxes) [1995] STC 766 (‘Horner’). In Horner, Lightman J accepted the Special Commissioner’s view that death, injury and disability all refer to medical conditions. Following Horner, the UT held that “injury” in section 406 refers to a medical condition and does not include injury to feelings.

For these reasons, the UT agreed with the FTT that the settlement payment falls within section 401 ITEPA, and that “injury” in section 406 does not include injury to feelings. It was also held that the taxpayer cannot rely on the additional tax free amount of £30,000 that HMRC originally offered as a concession.

The taxpayer’s appeal was dismissed.

The full judgment in this case is available from http://www.tribunals.gov.uk/