The income tax and national insurance treatment of termination payments under Part 6 ITEPA 2003. Mairs v Haughey; Moorthy v Revenue and Customs.
Damages; taxation; the Gourley principle. The House of Lords held that damages for loss of earnings are assessed on a net-of-tax basis: the claimant recovers what would have been received after tax and National Insurance, not the gross figure, because an award of gross earnings would leave them better off than if the dismissal had not occurred. The principle runs the other way too. Where an award will itself be taxed on receipt, as the excess over £30,000 is under ss.401 to 403 ITEPA 2003, the tribunal grosses up so that the tax does not leave the claimant worse off. It works from the net loss, deducts any unused part of the £30,000 exemption, then increases the balance to the gross sum that yields it after income tax; National Insurance is not levied on compensation [Principles for Compensating Pension Loss, 2.36-2.39].
Taxation; termination payments; the House of Lords held that a non-contractual termination payment is not taxable as an emolument under what is now s.62 ITEPA 2003 because it is not paid for services rendered but rather as compensation for not being able to continue earning a living from the former employment. The payment falls instead within what is now s.401 ITEPA (subject to the £30,000 exemption). A foundational authority on distinguishing earnings from termination payments.
Taxation of termination payments; the injury and disability exemption; s.406 ITEPA 2003 (formerly s.188(1)(a) ICTA 1988). The point decided in the High Court was the meaning of 'disability' in the exemption, on which the taxpayer failed. Lightman J also expressed the obiter view that the exclusion covered only injuries which prevented an employee from working. The case was not cited in Orthet Ltd v Vince-Cain, which treated injury to feelings awards as exempt; the First-tier Tribunal in Moorthy preferred Horner, but the EAT in Timothy James Consulting Ltd v Wilton distinguished it as concerning disability rather than injury and as not about a discrimination award, and the Court of Appeal in Moorthy [2018] ICR 1326 sided with Vince-Cain and Wilton on injury to feelings.
Compensation; taxation; injury to feelings; mitigation by retraining. The EAT (HHJ McMullen QC) held that a tribunal was entitled to award £15,000 for injury to feelings without reference to tax. It had been shown no authority or commentary asserting that tax is payable on such an award. The statutory exemption for sums paid on account of injury to or disability of an employee, now s.406 ITEPA 2003, pointed the other way; there was therefore no error in not grossing up [IDS 37.157]. Where the position is unclear the employer can give a tax indemnity or a review can be sought. Yorkshire Housing Ltd v Cuerden EAT 0397/09 called the suggestion that all such awards are exempt 'controversial' and decided only that awards for pre-termination discrimination are untaxed; Timothy James Consulting Ltd v Wilton [2015] ICR 764 revisited the point. Since 2018/19, s.406(2) as amended excludes injured feelings from 'injury', so an award connected with termination falls within the charge above £30,000. The case is also authority that retraining, here a university course, may be reasonable mitigation [IDS 37.50].
Pre-Finance Act 2017 authority on the tax treatment of injury-to-feelings awards connected with termination. The Court of Appeal held that a payment genuinely referable to personal injury (including discrimination-related hurt) could fall within the s.406 ITEPA 2003 exemption. The Finance Act 2017 subsequently excluded injury-to-feelings awards connected with termination from that exemption for payments from April 2018 onwards, making such awards fully taxable within the s.401 regime above the £30,000 threshold.
A £1,055,000 settlement of an ET claim for sexual harassment included confidentiality and non-disclosure obligations. The FTT held the payment was a restrictive undertaking within s.225 ITEPA 2003, not a termination payment under s.401: the entire sum was taxable as employment income with no £30,000 exemption, and subject to employees' NI. A cautionary authority: including NDA obligations in a settlement agreement risks HMRC recharacterising the payment as a restrictive undertaking, stripping the recipient of s.401 relief entirely.
Taxation of settlement payments; s.401 ITEPA 2003. A £6m payment settling ET discrimination and victimisation claims relating to the claimant's employment and its termination was taxable as employment income: 'otherwise in connection with' termination requires a factual connection only, and settlement negotiations do not break it. The exemptions operated within the taxed sum: £30,000 under s.403, £40,000 agreed for injury to feelings quantified by Vento (at [38], injury to feelings for discrimination, as opposed to financial loss, is not taxable), and £400,000 legal costs exempt under s.413A because the agreement provided for payment directly to the claimant's solicitors under a specific term covering advice on the termination and the tribunal proceedings. Authority both for the breadth of the s.401 net and for the drafting that secures the s.413A legal-costs exemption within it.
Taxation of an ET settlement; ss.401, 403, 406 and 225 ITEPA 2003. A payment of £183,750 settling unfair dismissal and disability discrimination claims after a redundancy dismissal comprised £21,288.42 redundancy pay and £162,461.58 under the settlement agreement. HMRC's closure notice treated £18,000 as non-taxable compensation for injury to feelings from pre-termination discrimination and the remaining £165,750 as a termination payment within s.401, taxable above the £30,000 threshold, most of which the redundancy payment had already absorbed, leaving £8,711.58 [3], [92], [97]. The FTT agreed: applying Moorthy, the only question is whether the payment was received directly or indirectly in consideration or in consequence of, or otherwise in connection with, the termination; no close nexus is required and Oti-Obihara was wrongly decided [103], [107], [181]. The s.406 exemption for payments 'on account of disability' was refused, applying Horner v Hasted: the taxpayer's disability discrimination claim did not make the settlement a payment on account of his disability. To the extent the sum was paid for confidentiality and non-disparagement it was in any event taxable under s.225 as a restrictive undertaking [178]-[179]. The taxpayer bears the burden of any apportionment [6].