A recent First-Tier Tribunal raised an interesting point with regard to the rules on Termination Payments under ITEPA 2003, s.401.  These rules apply not only to compensation payments made on termination, but also a change in the duties of a person’s employment or a change in the earnings from a person’s employment, and can mean that the first £30,000 of such qualifying payments is exempt from Income Tax.

An important point to note however, is that these rules only apply where there is not already a tax charge under another heading per s.401(3).  In the case of payments made due to a change in duties this presents difficulties, as the payment could be taxed as normal employment income if the payments are found to be emoluments.

This is how the taxpayer in A Hill v HMRC (TC04480) came unstuck.  The taxpayer had his employment transferred under the Transfer of Undertakings Regulations 2006 but was not happy with the new conditions.  A compromise agreement was made under which each company paid him £15,000 in settlement of his complaints. He was required to continue working for the new company and would have to repay them both if he left within two years.

The taxpayer argued that the payments should be exempt under ITEPA 2003, s 403, however HMRC argued that they were taxable.

The First-tier Tribunal decided the payments were consideration for agreeing to accept a change in his contract of employment, however the fact he was required to continue working, and would have to repay the sums if he did not, showed they referred to his continuing employment. As such they were taxable as emoluments and not exempt.

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.

Termination payments, specifically a payment in lieu of notice, were considered in the recent First-tier tribunal case of Kayne Harrison v HM Revenue & Customs.

Mr Harrison had been dismissed on 16 February 2006 without written notice and had successfully won a small amount of compensation from an Employment tribunal.

Three days after he was dismissed, his employers made a termination payment, consisting of a payment in lieu of notice.  This termination payment was made in line with the terms of his employment contract.  Mr Harrison argued that as his position was terminated without written notice, the payment was not contractual as it had been made in circumstances outside of his contract.  He believed that the findings of the Employment tribunal backed up this belief.

The tribunal found that Mr Harrison’s interpretation of the Employment Tribunal was incorrect in that they found the payment in lieu of notice had been made in accordance with the contract.  Despite the issues raised at the Employment Tribunal, Mr Harrison’s employment had ended on 16 February 2006 and the payment had been made in accordance with his contract.

HMRC were therefore correct to argue that the payment was taxable and the tribunal dismissed Mr Harrison’s appeal.

In the recent case of Goldman (TC 01999) the tribunal found that a payment made to an employee for termination of their contract was taxable as earnings under ITEPA s.62 and did not therefore qualify for the £30,000 statutory exemption.
The taxpayer had contended that the amount agreed under the terms of a compromise agreement was received not as earnings but as damages because the employer failed to make the payment in lieu of notice (PILON) within 14 days of termination, thus making them in breach of contract.
However, the tribunal found that where a payment is made in respect of a contractual provision it should be regarded as an emolument and not damages.
In reaching this conclusion the tribunal said that if the taxpayer was correct it would be possible for anyone entitled to a payment in lieu of notice to ensure the availability of the £30,000 exemption by accepting an amount in settlement of the claim to enforce the contractual contract.  This was considered to be inconsistent with a purposive interpretation of the legislation.
On the other hand, in the case of Rubio (TC 02047) the tribunal decided that a termination payment was not earnings under s.62 but a payment of damages.  This was particularly relevant because the taxpayer spent a lot of time abroad therefore the foreign service exemption was available.
In this case, the taxpayer had been seconded from Spain to the UK.  The UK company issued a new contract which stated that he was on leave from the Spanish company.  HMRC therefore stated that the original Spanish contract was automatically reinstated when he ceased employment with the UK company (and under the terms of which he would have been contractually entitled to a PILON).  However, the tribunal did not agree with this interpretation.
These cases demonstrate that where an employer is making a termination payment, the facts should be looked at carefully in order to determine whether or not the payment is contractual or a non contractual payment of damages.