More challenges to taxation of Settlement Agreement payments?

In a tax case just published, the Tax Chamber of the First Tier Tribunal has made an important decision which will have impact for employees and for employers in the tax treatment of certain types of compensation payments to employees on the termination of employment.

In A –v Commissioners for HM Revenue & Customs the case concerned a trader who had raised a grievance against his employer bank, asserting breach of contract and race discrimination in his being paid lower bonuses than other employees, because of his race.

Following a grievance process that was unresolved and the serving of a discrimination questionnaire on the bank in relation to race discrimination, the employee was then informed he was to be made redundant and he accepted a Settlement Agreement.

The payment by the bank to the employee comprised a statutory redundancy payment of £1,650, an ex gratia redundancy payment of £48,898 and £600,000 in settlement of all outstanding and potential claims.

The case arose because HMRC later required a breakdown from the bank of the £600,000 payment, for tax purposes.

The bank informed HMRC that whilst it rejected the potential discrimination claims they had accepted that they held certain merit and that there was a risk that the employee might have succeeded in claiming some right to higher bonus payments.   On this basis HMRC decided the £600,000 payment should be taxed as earnings from employment under section 62 ITEPA, as it had the aim of making up otherwise shortfalls in salary and bonus.

An appeal was made by A against that decision to the First Tier Tribunal on the basis that the sum was in fact compensation in respect of the potential race discrimination claim.

The First Tier Tribunal has accepted that assertion and granted the appeal in principal.  They decided that the payment for settling a claim, or potential claim, should be treated as an award for a successful claim because this was the only sensible way to treat it.  It was not necessary to consider whether the employee’s potential claim would have been successful.  It found the reason the payment was made was to settle a discrimination claim and it could not be categorised as a payment to repay under-paid salary or bonuses which an employee was entitled to under a service agreement.

The First Tier Tribunal therefore held that the payment was not “earnings” under section 62 ITEPA but was paid in respect of the claim for race discrimination.

This is potentially a decision with wide ranging implications. It is likely that there will be more challenges by employees, and those advising them, to the taxation arrangements proposed by employers for payments on termination of employment, where an employee has intimated potential claims against the employer either before or during the negotiations on termination.

This guide is for general information and interest only and should not be relied upon as providing specific legal advice. If you require any further information about the issues raised in this article please contact the author or call 0207 404 0606 and ask to speak to your usual Goodman Derrick contact. Information correct as at 15 May 2015.