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Compensation for injury to feelings is not taxable, says Court of Appeal

A termination payment made to an employee for 'injury to feelings' following age discrimination related to his dismissal is not taxable, the Court of Appeal has said in a ruling which overturns a decision by the Upper Tribunal.04 May 2018

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

Overturning a decision by the Upper Tribunal, the Court of Appeal confirmed that payments for injury to feelings could fall within an exemption that allows termination payments "on account of injury" to be paid tax free. In doing, so the Court of Appeal overturned an earlier decision by the Upper Tribunal, which ruled that the tax exemption for injury payments was confined to medical conditions.

The decision dealt with section 406 of the Income Tax (Earnings and Pensions) Act of 2003 which says that some payments related to death or disability can be paid tax free.

Tax expert Chris Thomas of Pinsent Masons, the law firm behind, said: “The Court’s decision is interesting as this has been a controversial issue, and many practitioners had doubts as to whether a payment of injury to feelings could ever be within section 406, especially given the case law on the need for an identified medical condition that disables or prevents the employee from carrying out the duties of the employment.

"Such damages will ordinarily be payable in settlement of a claim, and HMRC’s position has long been that section 406 only applies where the payment is made on account of disability and nothing else, thereby challenging its application where the payment is made to settle claims, as often arises in the case of a DDA claim," said Thomas.

"The case is of largely historic interest now given that the legislation has been amended from April 2018 to specifically preclude payments for injury to feelings falling within the exemption," he said. "So it will be necessary to consider whether the discrimination was connected to termination and, if so, tax it if the total ex gratia/damages payments exceed £30,000."

"However, it remains significant due to the potential wider implications. It will be interesting to see if HMRC seeks to appeal, but in the meantime employers would be well advised to continue with a cautious approach and only rely on the exemption where there is a clear, evidenced medical condition which prevents the employee from performing their role.”