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Taxation: Settlement Monies for Injury to Feelings

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 Thanks to Paul Smith of Broadway House Chambers for preparing this case summary

Are injury to feelings payments taxable?

If the payment arises out of the termination of employment, probably yes, held the First Tier Tribunal (Tax Chamber) in Moorthy v Revenue & Customs Commissioners.

The Appellant brought employment tribunal claims against his former employer, both in respect of the termination of his employment and also unlawful discrimination. The claims were subsequently settled in a global figure of £200,000.

No special provision was made in the settlement agreement that part of that sum was being paid in respect of perceived injury to feelings; indeed, the Appellant's argument was that none of the settlement sum was taxable as it had been paid in settlement of a discrimination claim. Whilst disagreeing, the Commissioners conceded that a £30,000 portion of the global sum would not be subject to taxation because it represented compensation for injury to feelings at the maximum allowable under the Vento and Da'Bell guidelines.

The First Tier Tribunal rejected the Appellant's argument that none of the sum was taxable, but curiously it also rejected the Commissioners' stance that injury to feelings awards are not taxable. Any payment made "directly or indirectly in consideration or in consequence of, or otherwise in connection with" the termination of employment was said to be taxable under s.401 Income Tax (Earnings and Pensions) Act 2003, and as the Appellant's payment came within that bracket the whole of it (save for the usual tax-free portion under s.403) would be subject to taxation.

The First Tier Tribunal drew a distinction between cases where injury to feelings compensation is paid where it is, or is not, "directly or indirectly in consideration or in consequence of, or otherwise in connection with" the termination of employment. In many cases this will be a difficult line for practitioners to draw where a termination (for whatever reason) has occurred, but it will not apply in situations where discrimination is alleged but where the employment relationship continues.