One of the most frequently asked questions in HR is whether or not a settlement payment is taxable. Several different and apparently conflicting answers can all be correct, depending on the circumstances. In 2014 I wrote about the £30,000 tax exemption which does not apply in all circumstances and in 2011 I highlighted a potential trap for employers.
Now we have a further and significant contribution in the form of a decision by the Tax Chamber of the First Tier Tribunal in the matter of Mr A v HMRC. It is a basic principle of tax law that earnings are taxable. Unsurprisingly HMRC interprets “earnings” widely as including any payments in respect of which earnings are involved (section 62 Income Tax (Earnings and Pensions) Act 2003). As a result severance payments are frequently regarded as taxable (subject to the £30,000 exemption pursuant to sections 401 to 404A of the 2003 Act when applicable).
Mr A worked as a trader for a Bank in London. His job title was managing director and he was on a basic salary of £120,000 plus eligibility for the Bank’s bonus scheme. In the period from 2003 to 2007 he received significant bonuses based on the bank’s overall performance. In 2007 there was a dispute concerning his bonus and when the Bank was bought out he was made aware of imminent redundancies. He raised grievances including allegations of race discrimination (based on inappropriate comments made by the bank’s chairman and vice chairman).
In early 2008 he raised further grievances including the fact that other directors had received bonuses and he had not. A questionnaire was sent to the employer in accordance with the relevant provisions of the Race Relations Act (as it then applied). On March 2008 the Bank informed Mr A that he was to be made redundant and he was offered £1650 in statutory redundancy pay and a further ex gratia redundancy payment of £48,898. A couple of days later Mr A was offered a further payment if he agreed to sign a compromise agreement (now referred to as a settlement agreement). The agreement provided that in addition to the payments already offered he would receive a further payment of £600,000 in settlement of all outstanding claims. The terminology used will be familiar to those who have dealt with settlement agreements:
The parties have entered into this Agreement to record and implement the terms on which they have agreed to settle all outstanding claims which the Employee has or may have against the Employer…arising out of or in connection with or as a consequence of his employment and/or its termination. The terms…are without any admission of liability on the part of the Employer…
Unsurprisingly HMRC queried the £600,000 payment and asked for a detailed breakdown of what it consisted of. They were told, in accordance with the compromise agreement, that it was in settlement of “all and any claims relating to his employment and the termination thereof”. It was noted that there was no allocation of specific amounts but the Bank “decided that his claims held certain merit and [it] also had issues with dealing with the grievances, and any potential proceedings in terms of witnesses”.
HMRC contended that even if the £600,000 was effectively in settlement of a claim for race discrimination and therefore equated to damages rather than loss of earnings, the damages are nonetheless calculated by reference to earnings and should therefore be taxable under section 62 ITEPA 2003. The tribunal went on to consider whether whether proof of discrimination was required. This would obviously be difficult bearing in mind that there was a settlement payment in respect of prospective claims rather than a tribunal award. It decided, reasonably, that such proof is not required. the question is whether the payment was “an emolument of an employment”. “The crucial element for the purposes of the taxing provision in s62 ITEPA is that the payment is not a reward for past or future services but for something else.” It followed that the payment made in this case was not in respect of earnings as defined in the Act and Mr A’s appeal against HMRC’s amendment to his self-assessment for 2008-2009 was allowed.
Incidentally it is worth noting that although the appeal was in respect of a self-assessment dating back to 2009 and the hearing took place in May and August 2014 the judgment was not handed down until 27 May 2015!