Tax tribunal holds that compensation for injury to feelings is taxable

In the absence of a codified system of law (such as that which operates in France) there is a risk that conflicts can arise between different jurisdictions and courts. For example, an insolvency court might make an order concerning property while a family court (applying its different rules) may make a conflicting order in respect of the same property. Which one prevails?

Another example is whether someone is an employee for tax purposes and for employment law purposes. It is possible to be an employee in one sense and not the other.

Another area of contention is whether compensation is taxable. The generally accepted view is that compensation for injury constitutes damages and as such should be tax free. However, compensation for financial losses, e.g. loss of earnings, should be taxable subject to the usual allowances and exemptions. In Moorthy v Commissioners for HM Revenue and Customs the Tax and Chancery Chamber of the Upper (Tax) Tribunal considered whether compensation for injury to feelings should be taxable.

Mr Moorthy worked for Jacobs Engineering (UK) Limited. In March 2010 he was made redundant and received a statutory redundancy payment of £10,640. He brought proceedings claiming unfair dismissal and discrimination. Following mediation he entered into a settlement agreement which provided for him to receive an “ex gratia payment of £200,000 by way of compensation for loss of office and employment”. Jacobs treated the first £30,000 as free of tax applying the usual exemption (section 403 Income Tax (Earnings and Pensions) Act 2003). Basic rate income tax was deducted from the remainder. Mr Moorthy completed his 2010-11 tax return on the basis that the full settlement amount was tax free. HMRC disagreed and amended the return to include an additional £140,023 taxable income. The issues on appeal were (1) whether the settlement payment was in connection with the termination of employment and was therefore chargeable to income tax (subject to the £30,000 exemption) (section 401); (2) if so, was it taken out of the charge to tax as a payment or benefit “on account of injury to…an employee”, namely injury to feelings (section 406); and (3) whether Mr Moorthy could rely on the concession made by HMRC in the closure notice that £30,000 of the settlement amount should be treated as damages for age discrimination and therefore not chargeable to income tax.