Keith Murphy v The Commissioners for HMRC

For the purposes of Income Tax (Earnings and Pensions) Act 2003, section 62(2)(b), a taxable employment “profit” is the employee’s net profit. Where an employee necessarily incurs legal funding costs and insurance costs to obtain a settlement payment arising from employment, those costs reduce the profit obtained from that payment.

The source of the settlement payment and the amount of profit derived from it are distinct questions. A payment may be derived from employment, yet expenditure necessarily incurred to obtain it must still be deducted in calculating taxable profit under section 62(2)(b).

Keith Murphy, a Metropolitan Police officer, joined group proceedings seeking unpaid overtime and hardship allowances. The claims settled. The employer paid a global settlement sum, including payments made directly to the claimants’ lawyers under a damages-based agreement and to their legal-expenses insurer.

HMRC assessed Mr Murphy on his apportioned share of the principal settlement sum without deducting a share of the success fee or insurance premium. The First-tier Tribunal dismissed his appeal, holding that those payments were employment income because the principal sum settled employment claims. Mr Murphy appealed to the Upper Tribunal on the meaning of “profit” in section 62(2)(b) of the Income Tax (Earnings and Pensions) Act 2003.

1. Appeal allowed. The First-tier Tribunal had erred in law by deciding the matter solely through the source-of-payment question and failing to determine the separate question of the “profit” obtained under section 62(2)(b) of the Income Tax (Earnings and Pensions) Act 2003.
2. Whether a payment is derived “from” employment remains a question of characterisation. The court adopted the summary in Kuehne & Nagel Drinks Logistics Ltd v HMRC, [2012] EWCA Civ 34: there must be a sufficient causal link between the payment and employment, rather than merely the fact that the recipient was an employee.
3. Section 62(2)(b) nevertheless requires the court to identify the actual profit obtained. The reimbursement authorities, and the reasoning accepted in Eagles v Levy, showed that an employee does not obtain taxable profit to the extent that a payment merely meets expenditure necessarily incurred to obtain it.
4. The agreed costs, success fee and insurance premium were economically indistinguishable. Each was incurred to pursue the claim against the employer and obtain the settlement. The fact that the success fee arose under a damages-based agreement, and that the settlement agreement directed payment to the lawyers and insurer, did not make those costs the claimants’ private affairs unconnected with their employment claims.
5. The tribunal set aside the First-tier Tribunal’s decision and remade it. Mr Murphy’s taxable employment income was his proportion of the principal settlement sum less his proportionate shares of the success fee and insurance premium. Those sums were not earnings under section 62.

• Upper Tribunal (Tax and Chancery Chamber): allowed the appeal, set aside the First-tier Tribunal decision, and remade the decision in Mr Murphy’s favour: [2021] UKUT 152 (TCC).
• First-tier Tribunal: dismissed Mr Murphy’s appeal against discovery assessments, holding that the whole principal settlement sum, including amounts used for the success fee and insurance premium, was taxable employment income. The decision was released on 11 November 2020; no citation is stated in the judgment.