HM Inspector of Taxes v Clayton

For tax purposes, a payment under a consent order settling an unfair-dismissal claim must be characterised by its true connection, not merely by the reinstatement fiction that the employee was never dismissed. A payment is an emolument from employment only where it is paid in return for acting as or being an employee, as a reward for past services, or as an inducement to future services. A mere but-for connection with employment is insufficient. A genuine arm’s-length compromise is not a benefit under section 154 of the Income and Corporation Taxes Act 1988 absent evidence of a gratuitous element. No precise valuation of the employee’s consideration is required. The payment fell within section 148 and, being below £30,000, was not chargeable under that provision.

The taxpayer’s employer terminated his contract after he refused to agree to the withdrawal of his Essential Car User Allowance, and immediately re-employed him on altered terms. An Employment Tribunal found that the dismissal was unfair. The parties then agreed a consent order providing reinstatement, restoration of the allowance and payment of £5,060 described as a basic award under section 119 of the Employment Rights Act 1996.

The General Commissioners held that the payment was received in connection with termination and was exempt under section 148 of the Income and Corporation Taxes Act 1988 because it was below £30,000. Patten J dismissed the Crown’s appeal. The Court of Appeal considered whether the payment was taxable as an emolument, as an employment benefit, or as a termination payment.

1. Appeal dismissed. The £5,060 payment was made pursuant to a consent order settling the unfair-dismissal proceedings. Its character was not altered by the fact that the order also provided reinstatement.
2. Under section 19 of the Income and Corporation Taxes Act 1988, a payment is an emolument from employment only where the necessary causal link with employment is established. It must be paid in return for acting as or being an employee, as a reward for past services, or as an inducement to enter employment or provide future services. It is insufficient that the employee would not have received the payment but for being an employee. The payment here compensated the taxpayer for unfair dismissal and was not remuneration for employment.
3. The direction in section 114(1) of the Employment Rights Act 1996 to treat an employee as if he had not been dismissed does not override the actual facts for tax purposes. Regulations preserving continuity of employment operated only for the statutory purposes for which they were made.
4. Section 154 of the Income and Corporation Taxes Act 1988 contains an implicit exclusion for receipts from fair bargains. A genuine arm’s-length compromise of hostile litigation is not a taxable benefit merely because the employer pays money to the employee. The court need not establish that the employee’s consideration was precisely equivalent in value. Section 154 might apply to a gratuitous element within a compromise, but there was no evidence of such an intention here. The court adopted the approach in Mairs v Haughey (1992) 66 TC 273 and Hochstrasser v Mayes [1960] AC 376.
5. The court declined to resolve the Crown’s new argument that section 203 of the Employment Rights Act 1996 invalidated the compromise, or that the Tribunal lacked jurisdiction to make the order, because those issues were unnecessary to determine the tax treatment. The payment was received in connection with and in consequence of termination under section 148 of the Income and Corporation Taxes Act 1988. As it did not exceed £30,000, it was not chargeable under that section. The appellant was ordered to pay the respondent’s appeal costs.

• Court of Appeal (Civil Division): dismissed the Crown’s appeal and ordered the appellant to pay the respondent’s costs.
• High Court of Justice, Chancery Division: Patten J dismissed the Crown’s appeal from the General Commissioners.
• General Commissioners: allowed the taxpayer’s appeal against the amendment to his self-assessment.