Taxable payments

The law states that the first £30,000 of any payment made on termination of employment is exempt from tax, but what about payments made for injury to feelings? In Moorthy v HM Revenue and Customs (HMRC) the First-Tier TaxThe law states that the first £30,000 of any payment made on termination of employment is exempt from tax, but what about payments made for injury to feelings? In Moorthy v HM Revenue and Customs (HMRC) the First-Tier Tax Tribunal held that if the payment is made on termination of employment, then the whole payment (minus £30,000) is liable to tax.

Basic facts

Shortly after being made redundant from his job on 12 March 2010, Mr Moorthy received a statutory redundancy payment just short of £11,000 from which no tax was deducted.

Following his dismissal, he claimed unfair dismissal and age discrimination for which he claimed basic and compensatory awards, compensation for financial loss, an award for injury to feelings and interest. The claim was settled as part of a compromise agreement under which the company agreed to make him an ex gratia payment of £200,000. It did not stipulate that part of the payment was to compensate Mr Moorthy for injury to feelings.

When he completed his tax return for 2010 to 2011 Mr Moorthy claimed that the payment was not taxable on the basis that it had been made to settle a discrimination claim. HMRC contended, however, that it was taxable as a termination payment under Income Tax (Earnings and Pensions Act) 2003 (ITEPA) section 401. It argued that the only exemption applied to the first £30,000 under section 403, but it allowed a further £30,000 to cover compensation for injury to feelings.

On 13 August 2013 HMRC issued a closure notice and amended Mr Moorthy’s
self-assessment return by including £140,023 in his taxable income for the 2011 to 2012 tax year. Mr Moorthy appealed the amendment and his appeal was subsequently notified to the First-Tier Tribunal Tax Chamber.

Relevant law

Section 401 ITEPA “applies to payments and other benefits which are received directly or indirectly in consideration or in consequence of, or otherwise in connection with … the termination of a person’s employment”.

Section 403 states that a payment counts as employment income to the extent that it exceeds the £30,000 threshold; section 404 describes how the £30,000 threshold applies; while section 406 exempts death or disability payments.

Decision of First Tier Tribunal

The tribunal held that to fall within section 401, there had to be a “connection” or some sort of “link” between the payment and the termination. In this case, there was a clear connection between the termination of Mr Moorthy’s employment and the selection process as well as a connection between his compensation payment and the alleged discrimination during that process. The total payment therefore fell within section 401.

To add to his woes, the tribunal also held that HMRC should not have exempted £30,000 of the payment for injury to feelings. The statute was clear, according to the tribunal - any payment made directly or indirectly to do with termination of employment is taxable unless it falls under section 403, the death/disability exemptions in section 406 or the other specified exemptions in sections 407-414A. None of the exemptions applied in this case.

Finally, as termination payments from the same employer have to be aggregated under sections 403 and 404 (whether they occur in a single tax year or more than one tax year), Mr Moorthy had therefore used up part of his £30,000 exemption in the previous tax year when he received his redundancy payment, meaning that he could only set off the balance of just over £19,000 against the £200,000 payment.