Compensation Pitfall – Don’t Look an HMRC Gift Horse in the Mouth!

In the First-Tier Tribunal case of K Moorthy (TC3952) the judge noted that the taxpayer ended up in a worse position regarding his compensation for loss loss of office following the decision than if he had accepted an earlier offer made by HMRC.

ITEPA 2003, s.401 catches payments made directly or indirectly in consideration of a termination of employment. Unfortunately, in this case the tribunal found that the entire sum of £200,000 which had been paid to the taxpayer fell within the scope of s.401.

Following redundancy in March 2010, the taxpayer argued that he was discriminated against because of his age and subsequently looked to take his case to an Employment Tribunal. As a result of mediation, the Company paid the taxpayer an ex gratia sum of £200,000 as compensation for loss of office and employment. This was paid in 2010/11 under an agreement that the first £30,000 was paid free of tax and the balance subject to a 20% tax deduction. The taxpayer claimed a refund of £34,000, on his tax return, stating the tax had already been deducted and that it should be fully exempt as it was paid to settle his discrimination claim and protect the company’s reputation.

HMRC considered the full amount to be taxable but by “concession and in order to try and reach agreement” offered to treat £60,000 as tax exempt. The taxpayer appealed because he felt the the full amount should be exempt. He also revealed that the Company had previously made a statutory redundancy payment of £10,640.

The taxpayer’s appeal was unfortunately dismissed with the judge ruling that the £30,000 exemption should be reduced to take into account the statutory redundancy payment of £10,640. Further the judge ruled HMRC’s additional £30,000 allowance was an ‘unlawful concession’ that the Tribunal could not take into account.

Clearly, the facts in each compensation for loss of office/employment case are different. As ever obtaining professional advice is sensible. It is possible that suitable advisors could have informed Mr Moorthy that the deal offered by HMRC was a good one and therefore saved him a substantial amount of tax.