Moorthy v The Commissioners for HMRC

The Court of Appeal considered whether a global settlement paid to an employee following mediation and termination of employment was taxable as employment income under Chapter 3 of Part 3 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) and whether any part of it fell outside the charge by reason of the exception in section 406 for payments on account of injury to an employee. The court upheld the lower tribunals on the taxability point, holding that section 401 has wide scope and can catch non-pecuniary awards if they are "in consideration or in consequence of, or otherwise in connection with" termination. On the exemption point the Court of Appeal allowed the appeal: it concluded that "injury" in section 406 can include injury to feelings in the context of a statutory discrimination claim, and accordingly declared that £30,000 of the £200,000 settlement was exempt from income tax. The court also rejected the appellant’s complaint about incompatibility with section 124(6) Equality Act 2010 (the grossing-up point) and treated the earlier concession about £30,000 as falling with the legal conclusion on exemption.

Background and parties

The appellant, Mr Moorthy, reached a mediated settlement with his former employer, Jacobs Engineering (UK) Ltd, embodied in a deed of compromise under which he received a global payment of £200,000 in settlement of unfair dismissal and age discrimination claims. HMRC treated the payment as a termination payment chargeable under Chapter 3 of Part 3 of ITEPA 2003 and allowed deductions aggregating to £60,000 (one being the statutory £30,000 threshold and one a concession). The appellant sought a refund and a declaration that the payment (or part of it) was not taxable, arguing (inter alia) that compensation for injury to feelings fell within the exception in section 406.

Procedural history

• First-tier Tribunal (Tax Chamber) held the whole payment fell within section 401 and was taxable; the appellant conceded the section 406 point there.
• Upper Tribunal (Tax and Chancery Chamber) dismissed the appeal against HMRC on the taxability point and, after allowing withdrawal of the earlier concession, held that "injury" in section 406 referred to a medical condition and did not include injury to feelings, so the exemption did not apply.
• The case came to the Court of Appeal with permission, and the EHRC had provided written submissions to the Upper Tribunal which were relied on in this appeal.

Issues framed

1. Whether the settlement sum was taxable employment income under section 401 ITEPA 2003 (the taxability issue).
2. Whether any part of the payment fell outside Chapter 3 by virtue of section 406 ITEPA 2003 because it was provided on account of injury to the employee (the exemption issue), specifically whether "injury" can include injury to feelings arising from a discrimination claim.
3. Two subsidiary issues concerning HMRC's concession of £30,000 and whether requiring any grossing-up for tax would conflict with section 124(6) Equality Act 2010.

Reasoning and holdings

On the taxability issue the Court of Appeal agreed with the FTT and Upper Tribunal that the statutory language of section 401 is broad, and a payment described as compensation for loss of office and employment was plainly connected with termination and therefore within the charge. On the exemption issue the court disagreed with the Upper Tribunal’s restrictive reading: it held that "injury" in section 406 can be given its ordinary meaning and cover injury to feelings where those feelings form the compensatable injury in a statutory discrimination claim. The court observed the Vento bands and recognised the risk of attempts to convert substantial non-pecuniary settlement sums into tax-exempt awards, but found no policy objection to exempting modest awards for injury to feelings. The court further noted a later statutory amendment (Finance (No. 2) Act 2017) that, with effect from 2018/19, excludes injured feelings from the exemption, but treated that as not affecting the construction question before it.

Disposition

The Court of Appeal dismissed the appeal on the taxability and section 124(6) grounds, allowed the appeal on the section 406 exemption point, declared that £30,000 of the payment was exempt from income tax, and made no order on one procedural ground (the original concession).

The appeal was allowed in part. The court upheld the tribunals below that the entire £200,000 settlement was in principle caught by section 401 ITEPA 2003 and therefore prima facie taxable, but allowed the appeal on the exemption issue, holding that "injury" in section 406 can include injury to feelings in the context of a statutory discrimination claim and declaring that £30,000 of the settlement was exempt from income tax. The court dismissed the grossing-up/section 124(6) complaint and made no order in relation to the earlier concession.

First-tier Tribunal (Tax Chamber) decision: [2014] UKFTT 834 (TC) (FTT found the whole payment taxable). Upper Tribunal (Tax and Chancery Chamber) decision: [2016] UKUT 13 (TCC) (UT dismissed appeal on taxability and held "injury" meant a medical condition and did not include injured feelings). Permission to appeal to the Court of Appeal was granted by the Upper Tribunal.