Moorthy v The Commissioners for HMRC

Payments connected with the termination of employment fall within the broad charge in section 401 of the Income Tax (Earnings and Pensions) Act 2003, including payments for non-pecuniary loss and injury to feelings. The charge is not avoided because the payment is made after termination, is capital in character, exceeds statutory compensation limits, or settles several claims globally.

Before the 2018/19 tax year, section 406 exempted the fair proportion of a termination settlement paid on account of injury to feelings arising from actionable age discrimination. The exemption was not confined to medical conditions. A later statutory amendment excludes injured feelings prospectively.

Following his dismissal for redundancy, Mr Moorthy settled employment tribunal claims for unfair dismissal and age discrimination for £200,000. The settlement described the sum as compensation for loss of office and employment and made no allocation between claims.

The First-tier Tribunal held that the whole payment fell within section 401 of the Income Tax (Earnings and Pensions) Act 2003: [2014] UKFTT 834 (TC). The Upper Tribunal dismissed the appeal and held that injury in section 406 meant a medical condition, not injury to feelings: [2016] UKUT 13 TCC. The Court of Appeal considered the taxability of the settlement, the scope of the injury exemption, apportionment, and the alleged need to gross up discrimination compensation.

Henderson LJ gave the leading judgment, with Underhill LJ and Asplin LJ agreeing.

1. Taxability. The whole £200,000 settlement was received directly or indirectly in consequence of, or otherwise in connection with, the termination of employment. Section 401 of the Income Tax (Earnings and Pensions) Act 2003 is deliberately wide. It catches non-pecuniary compensation, payments made after employment has ended, payments of capital character, and sums exceeding the statutory maximum for unfair dismissal. The reasons for the payment and the absence of an admission of liability do not alter that conclusion. The first ground of appeal was dismissed.
2. Injury exemption. The word injury in section 406 has its ordinary meaning and is not confined to a medical condition or personal injury actionable in negligence. Compensation for injured feelings authorised by discrimination legislation can therefore qualify. The exemption operates only where Chapter 3 would otherwise apply, but it is not necessary that the injury caused the termination or changed the employee’s duties or earnings. The Court distinguished the limited and largely obiter reasoning in Horner v Hasted, and preferred the statutory focus in Timothy James Consulting Ltd v Wilton. The relevant proportion of the settlement was exempt.
3. Apportionment and grossing-up. Although the settlement was global and made without admission of liability, the parties accepted £30,000 as the amount attributable to the age-discrimination injury-to-feelings claim. The Vento guidance showed that this was within the appropriate range. Under section 124(6) of the Equality Act 2010, awards for identical loss must correspond whether made by an employment tribunal or the County Court. If an award is taxable, it must be grossed up to compensate for the tax, so the fourth ground was misconceived.
4. Disposition. The appeal was allowed on the exemption issue. £30,000 of the settlement was declared exempt from income tax under section 406. The appeal was dismissed on the taxability and grossing-up grounds, and no order was made on the remaining subsidiary ground. The Court noted that section 5(7) of the Finance (No 2) Act 2017 prospectively excludes injured feelings.

1. Court of Appeal (Civil Division). The appeal from [2016] UKUT 13 TCC was allowed on the section 406 exemption issue. £30,000 was declared exempt; the taxability and grossing-up grounds were dismissed.
2. Upper Tribunal (Tax and Chancery Chamber). The appeal from the First-tier Tribunal was dismissed. The Tribunal held that the settlement was within section 401 and that injury in section 406 did not include injury to feelings: [2016] UKUT 13 TCC.
3. First-tier Tribunal (Tax Chamber). The whole settlement was held connected with termination and taxable under section 401, subject to the deductions accepted by HMRC: [2014] UKFTT 834 (TC).