In Moorthy v The Commissioners for Her Majesty’s Revenue and Customs, The Upper Tax Tribunal recently considered whether a settlement sum paid to Mr Moorthy as compensation for injury to feelings in an age discrimination claim was to be treated as employment income, and whether it was therefore chargeable to income tax under the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”). The Upper Tax Tribunal found that the whole of the sum paid to Mr Moorthy (including the sum for ‘injury to feelings’ was chargeable to income tax.
In March 2010, Mr Moorthy was made redundant by his employer, Jacobs Engineering (UK) Limited. Mr Moorthy was subsequently paid £10,640 in statutory redundancy pay in the 2009-10 tax year, from which sum no tax was deducted. Mr Moorthy subsequently brought a claim in the Employment Tribunal against Jacobs Engineering (UK) Limited, alleging that his dismissal had been unfair and that he had been discriminated against on the grounds of his age.
Following mediation of his Employment Tribunal claim, Jacobs Engineering (UK) Limited agreed to pay Mr Moorthy £200,000 “by way of compensation for loss of office and employment” (“the Settlement Sum”). The payment was made to Mr Moorthy in the 2010-11 tax year, with £30,000 of the sum paid tax-free (the rest subject to income tax at the basic rate). Mr Moorthy completed his self-assessment tax return for 2010-11 on the basis that the Settlement Sum was tax-free. However, HMRC did not agree with this and in August 2013 HMRC issued a closure notice amending Mr Moorthy’s self-assessment return for 2010-11 to include an additional £140,023 as taxable income. As a concession and in order to reach an agreement HMRC offered to treat £30,000 of the £200,000 as damages of age discrimination and therefore not chargeable to income tax.
Mr Moorthy appealed against HMRC’s assessment and the case came before the First-Tier Tribunal. The First-Tier Tribunal (“FTT”) determined that:
- The Settlement Sum fell within s.401 ITEPA
- Taking into account the statutory redundancy payment of £10,640 made in the 2009-10 tax year, the £30,000 exemption allowed by s.403 ITEPA was reduced to £19,360
- The FTT had no jurisdiction to allow a further £30,000 relief treated, as a concession, by HMRC as damages for age discrimination (and outside the charge to income tax)
Mr Moorthy appealed the decision of the FTT to the Upper Tax Tribunal. The Upper Tax Tribunal found that the Settlement Sum did indeed fall within s.401 ITEPA, that “injury” under s.406 ITEPA did not include “injury to feelings”, and that Mr Moorthy could not rely in the proceedings upon the concession made by HMRC. Mr Moorthy’s appeal against the FTT’s decision was therefore dismissed.
Why is this case significant?
The Upper Tax Tribunal’s judgment deals with conflicting case law in the First-tier Tax Tribunal and Employment Appeal Tribunal relating to the taxation treatment of injury to feelings awards made in connection with the termination of employment. The FTT had previously held in Oti-Obihara v HMRC  UKFTT 568 (TC) that if the reason for the termination of employment is discrimination then any award in respect of the discrimination is taxable only to the extent that it is for financial loss caused by the termination of employment – to put this another way, the FTT held that sums payable as compensation for injury to feelings is not earnings and therefore not taxable. The Employment Appeal Tribunal has also recently espoused in Timothy James Consulting Ltd v Wilton UKEAT/0082/14 the view that awards for injury to feelings were not taxable (as they fell within the s.406 ITEPA “injury” exception). The effect of Moorthy tidies the conflicting case law up and is definitive – sums paid as compensation for injury to feelings claims will in future (subject to any further determination on the matter) will be treated as chargeable to income tax.
What effect will this case have?
This case clarifies the law relating to the taxation of termination payments under ITEPA and allows practitioners certainty when advising on such matters. However, one of the effects of Moorthy may be that it reduces the scope for settlement of discrimination claims, as previous to this decision one of the advantages to claimants of settling these claims was a further potential tax-free payment for injury to feelings.
Chris Hadrill, a solicitor at Redmans, commented on the case: “This case is highly relevant to claimants, respondents, and practitioners, and provides clarity and certainty as to the taxation situation. However, this decision may impact upon parties’ ability to settle existing discrimination and whistleblowing claims.”
The transcript of Moorthy v The Commissioners for Her Majesty’s Revenue and Customs can be found here.
Redmans Solicitors are specialist employment solicitors in Fulham, Hammersmith, Chiswick, and Richmond.