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HMRC can tax payments made for injury to feelings, said Upper Tribunal

A termination payment made to an employee for 'injury to feelings' is taxable, the Upper Tribunal (Tax and Chancery Chamber) has ruled. 01 Feb 2016

A Mr Moorthy had been paid £200,000 as compensation for "loss of office and employment", under an agreement that was signed after his termination from his job. His employer treated £30,000 of this as exempt from tax, but deducted tax at the basic rate from the rest.

Moorthy argued that the compensation should all be tax free because it was for age discrimination related to his dismissal. However, the Upper Tribunal, confirming the First-tier Tribunal’s decision, said that the only issue is whether the discrimination was connected to the termination of employment.

If it is connected to termination, the payment is taxable. As the compensation in this case was all related to the termination of his employment, aside from the usual £30,000 tax free exemption the rest of the payment was taxable. The tribunal concluded that a previous First Tier tribunal in a case between HMRC and a Mr Oti-Obihara had been wrong to distinguish between pecuniary and non-pecuniary awards for injury to feelings – if there is a connection with employment, then tax will apply to the whole payment.

The Upper Tribunal also said that payments for injury to feelings do not fall within an exemption that allows termination payments ‘on account of injury’ to be paid tax free. Only medical conditions fall within the ‘injury’ exemption and ‘injury to feelings’ arising from discrimination does not satisfy this test, it said. This conflicts with a previous Employment Appeal Tribunal (EAT) decision in a case between a company called Orthet and an ex-employee Sarah Vince-Cain, which found that the exemption could apply.

Tax expert Chris Thomas of Pinsent Masons, the law firm behind Out-Law.com, said: "This decision is helpful in clarifying that injury to feelings payments relating to discrimination connected with the termination are indeed taxable – whilst most advisors have always understood this to be so, recent case law had caused some confusion."

"It is no surprise that the exemption for 'injury' has been held not to apply. However, this could leave claimants and employers in a difficult position if the EAT continues to follow the decision it made on the Orthet case, as awards will fail to factor in the tax which employers will have to deduct when making the payment – potentially leaving some very disgruntled claimants. It is therefore to be hoped that the position is clarified by a decision in one of the higher courts sooner rather than later."

"It should be noted that the Moorthy case does not affect injury to feelings payments where the discrimination is not related to termination of employment – in those cases, employers can continue to pay awards tax free. When there is discrimination both before and during the termination process, the employer should consider whether an apportionment can realistically be made," Thomas said.