A City trader recently won a case at the First-Tier Tribunal confirming that a payment of £600,000 from his former employers could be treated as tax free.  The catch comes in the fact that the payment was made as a settlement as compensation for racial discrimination; however the payment was in part calculated by reference to lost earnings.

In Mr A v HMRC, HMRC argued that because the payment had been calculated by reference to Mr A’s lost bonuses and earnings, it should be treated as taxable as earnings.  Mr A argued that the payment represented compensation in relation to a threatened race discrimination claim against his employers , and that therefore no tax should be due.

Mr A was eligible to benefit from the bank’s “discretionary bonus scheme”, and during his first 6 months made a profit of €3m for the bank, receiving a bonus of €50,000. During the next year he made a profit of €9.1m for a bonus of €125,000, which was later increased to €725,000 after he challenged it.

Mr A felt that the bonuses were disproportionately small compared to his colleagues, and that he had also been overlooked for promotions.  He made a claim under the Race Relations Act 1976 (now replaced by the Equality Act 2010).  Eventually the parties entered into a compromise agreement for full and final settlement. The amounts paid included a statutory redundancy payment of £1,650, an ex-gratia redundancy payment of £48,898 and the further compensation sum of £600,000.

Ultimately, the courts found in favour of Mr A, stating that “while the discrimination may have manifested itself through the way in which the employee was remunerated, the damages arise not because the employee was under-remunerated but because the underpayment was discriminatory.”  They found that the payments were made due to the fact that Mr A had been discriminated against and that the fact that they were calculated by reference to lost bonuses and earnings did not make the sums earnings.

It is interesting that a sum of £178,922 which was part of the £600,000 figure was acknowledged to be in respect of a bonus that was underpaid in error, however the Tribunal still felt that this fell within the overall discrimination claim as it would not have been paid without the claim.

The case could have interesting implications for compensation payments in the future and highlights the importance of reviewing the tax implications of transactions at the time based on the facts.  It remains to be seen whether HMRC will look to appeal this case at the Upper Tribunal.