Richardson (Inspector of Taxes) v Delaney (11.6.01, unreported, Chancery Division High Court)

The High Court have held that a lump sum paid to an employee as part of a negotiated settlement on tennination of employment was not a payment of compensation for breach of contract and therefore was not subject to tax relief but was fully taxable as a payment derived from his employment under Schedule E. Section 148 Income and Corporation Taxes Act 1988 allows the rlrst £30,000 of a tennination payment to be tax free. The provision was originally introduced partly to facilitate dismissals and encourage labour market flexibility.

In this case, Mr Delaney was employed under a service agreement for an indefinite period terminable by either party on giving 18 months written notice. On 1 December 1995, Mr Delaney was informed by letter that his employment had been terminated and compensation for loss of office would be paid to him. Negotiations then took place during which time Mr Delaney remained on "gardening leave". A settlement was reached whereby Mr Delaney accepted the sum of £75,000 and transfer of a car. His employment ended on 28 December. Initially he was assessed as being liable for tax on the entire amount, but he successfully appealed to the general commissioners. They held that in terminating the employment, the employer was in breach of contract and that the £75,000 paid was caught only by section 148 with the first £30,000 being tax free.

The Crown, through the Inspector of Taxes, appealed against this determination to the High Court. Mr Justice Lloyd concluded that there was no basis for the commissioners' finding that the employers were in breach of contract. The letter of 1 December gave notice to Mr Delaney leaving him in the position of an employee but not requiring him to attend work - thereafter the parties reached a negotiated agreement and after that date, his employment terminated. The lump sum paid was an emolument of the employment and the whole amount was taxable under Schedule E. S. 148 refers to payments "received in connection with the termination of a person's employment". Mr Delaney's contract gave his employing company power to make a payment in lieu of notice (PILON) at its election to terminate the contract immediately. The exact words were "The Company may at its absolute discretion elect to terminate the employment of the Executive with immediate effect by paying to the Executive salary in lieu of notice".

Mr Delaney was given a letter which said "I am writing to give you notice to terminate your employment", but which went on to say that he would be required to take gardening leave while receiving salary in the normal manner and being available for work. From the facts, the judge held that the contract was therefore not immediately being terminated. After being on gardening leave for a month, Mr Delaney was then sent a letter proposing that the contract terminate by mutual agreement and that compensation for loss of office be paid. This was accepted and he was paid out.

It was held that this was a payment pursuant to the PILON in the contract -there was no breach of contract. In making the payment one month after he was sent home, the company was making a payment in lieu of the unexpired notice. The payment made was entirely in accordance with the contract and moreover was of a similar amount to that due under the contract (i.e. the unexpired notice) which merely served to highlight that this was a payment pursuant to the clause.

This is an important judgment affecting consensual terminations. A central part of the judgment in this case seems to be the fact that Mr Delaney's employment was not terminated until after the severance terms had been negotiated. Had Mr Delaney's employment been terminated on 1 December in fact, then it is likely that the resulting negotiation process and the severance terms that were reached towards the end of the month would have been seen as events taking place outside of the employment relationship such that the resulting severance terms would not have been taxable as emoluments or as "relationship-based payments". The case is being appealed to the Court of Appeal, but unless and until the case is overturned, care will need to be taken when negotiating termination payments in similar circumstances to Mr Delaney.