In the case of Moorthy v The Commissioners for HMRC the Upper Tribunal (Tax and
Chancery Chamber) has concluded that “injury” in section 406 of the Income Tax
(Earnings & Pensions) Act 2003 (‘ITEPA’) does not include injury to feelings.
In doing so, the Upper Tribunal has
squarely disagreed with the decisions of the Employment Appeal Tribunal (‘EAT’)
in Orthet Ltd v Vince-Cain  ICR
374 and Timothy James Consulting Ltd
v Wilton  ICR 764 which concluded that it did.
Eleena Misra discusses whether or not “injury”
in section 406 of the Income Tax (Earnings & Pensions) Act 2003 includes
injury to feelings.
KEY LEGISLATIVE PROVISIONS
Sections 401 and 406 ITEPA
salient parts of ITEPA are helpfully set out in Moorthy itself.
Jacobs employed Mr Moorthy as
Executive Director of Operations. Further to a restructuring process, Mr
Moorthy was dismissed by reason of redundancy. He was given notice on 12 March
2009 and placed on garden leave until 12 March 2010 when his employment
Mr Moorthy brought a complaint of
unfair dismissal and age discrimination (in dismissing him) in the Employment
Tribunal (‘ET’). He contended that he had been dismissed or selected for
redundancy on the grounds of his age, contrary to the Equality Act 2010.
Amongst the suite of remedies sought by Mr Moorthy was an award for injury to
feelings. However, further to mediation, a compromise was reached with his
former employer. Pursuant to the terms of a settlement agreement, Jacobs agreed
to and did pay Mr Moorthy ”an ex gratia sum of £200,000 by way of compensation
for loss of office and employment” without admission of liability. The sum was
not allocated to any particular heads of claim, but was expressed to be in full
and settlement of the ET claims as well as any other claims arising out of or
connected with the employment or its termination. The first £30,000 was paid on
a free of tax basis with the balance subjected to a 20% tax deduction.
A dispute arose as to the proper tax
treatment of the sums in question. The First Tier Tribunal (‘FTT’) found that
the whole of the settlement payment fell within section 401(1) ITEPA as it was
made “directly or indirectly in consideration or in consequence of, or
otherwise in connection with” the termination of Mr Moorthy’s employment.
The FTT recorded that it was no part
of Mr Moorthy’s case that “the payment fell within the exemption in ITEPA s 406
as being for injury or disability” although, on appeal to the Upper Tribunal,
counsel for Mr Moorthy disagreed that this correctly reflected the position
below, and was, in any event, allowed to argue the point before the Upper
Tribunal, which considered it to be an issue of importance upon which guidance
should be given.
The Upper Tribunal approached section
406 ITEPA on the basis that it operated to take certain payments out of the
charge to tax; section 401 had to apply before one considered the exempting
provision in section 406.
It went on to postulate that the
correct question under section 401 is whether the payment received is directly
or indirectly in consideration or in consequence of, or otherwise in connection
with, the termination of employment. If the answer is yes then section 401
applies whether or not there is a claim for discrimination. The existence of a
discrimination claim could be relevant where “the discrimination is unconnected
with the termination of employment” but “it does not change the question to be
addressed”. In this regard, the Upper Tribunal expressly disagreed with the FTT
in Oti-Obihara v HMRC  UKFTT 568
(TC), which it considered to have misinterpreted the earlier case of Walker v Adams  SpC 344; in Walker, said the Upper Tribunal, the
Special Commissioner did not have to consider the proper tax treatment of
payment said to have been made for injury to feelings because the Revenue had
conceded that it was not a payment made in connection with termination and
therefore this was not a point which needed to be argued. It was therefore
wrong to say, as the FTT held in Oti-Obihara,
that a compensation payment made by an employer to an employee was taxable
under section 401 ITEPA if the discrimination caused the termination and then
only to the extent of financial losses caused by the termination.
Turning to section 406, the Upper
Tribunal considered the predecessor provision (section 188(1)(a) ICTA), which
exempted from tax “any payment made in connection with the termination
of…employment by the death of…or made on account of injury to or disability of
[the employee]” as had been considered and applied in Horner v Hasted (Inspector of Taxes)  STC 766, a decision of
the High Court on appeal from the Special Commissioner. In Horner, said the Upper Tribunal, injury was implicitly accepted to
be a medical condition preventing the carrying out of employment duties.
Unfortunately, Horner had not been cited to the EAT in Orthet a case in which an employee had been paid £15,000 for injury
to feelings in a sex discrimination case. The EAT held that injury to feelings
were not taxable whether or not they arose from the termination of employment,
giving its key rationale in paragraph 33 (recited in paragraph 47 of Moorthy). When the EAT came to grapple
with the issue again, in Timothy James,
it now had the benefit of arguments on Horner,
as well as the FTT decision in Moorthyitself, but Singh J concluded that it would not have made any difference to the
outcome in Orthet and that it should
The Upper Tribunal, taking each of the
EAT’s reasons in Orthet in turn,
held that they “provide very little support for their conclusion that awards
for injury to feelings, whether in connection with the termination of
employment or otherwise, are not taxable.”
Instead, the Upper Tribunal held that
the word “injury” in section 406 fell to be considered and interpreted together
with “death” and “disability” as something which had led to the termination of
employment or to a change in duties or level of earnings. Further, contrary to
the view taken by the EAT in Timothy
James, the Upper Tribunal found that the side-note to section 406, which
refers to an exception for death or disability payments and benefits supported
an interpretation of the word “injury” as meaning “a medical condition that
results in the termination of employment or a change in duties of earnings
related to the employment” and did not include injury to feelings.
One may quibble with the Upper
Tribunal’s treatment of section 406 ITEPA as an exempting as opposed to an
excepting provision. However, on the whole, some clarity is provided further to
a series of apparently conflicting tax decisions.
That said, as regards section 406
ITEPA, there is now directly conflicting authority on point from two courts of
superior record: Orthet and Timothy James at EAT level as against
the Upper Tribunal’s decision in Moorthy.
This is unlikely to be the last word on the issue.
For now, adopting the approach of the
Upper Tribunal, where an award or settlement payment received is directly or
indirectly in consideration or in consequence of, or otherwise in connection
with, the termination of employment then it matters not whether there is a
discrimination claim when deciding whether section 401 ITEPA applies. There is
no discrimination claim or injury to feelings ‘carve out’ for section 401.
However, practitioners should note the
decision in A v HMRC  UKFTT 0189
(TC), in which section 62 ITEPA (earnings) was engaged for the purpose of
the tax charge. Here A, a trader in a bank, made a claim of race discrimination,
alleging that he had been treated less favourably in connection with the
payment of salary and annual bonuses. He was later dismissed by reason of
redundancy, his grievances not having been addressed by that time, further to
the acquisition of his employer by a larger bank. He was paid sums in
connection with the redundancy and £600,000 in settlement of all outstanding
and potential claims. HMRC did not seek to argue that section 401 applied. The
Upper Tribunal noted that, in that case, this may have been because it was
common ground that the payment related to allegedly discriminatory treatment
during the course of A’s employment rather than the dismissal (in respect of
which separate payment had been made).
Accordingly, there is still scope to argue
that a settlement sum in respect of injury to feelings and losses relating to
discrimination prior to dismissal i.e. separable from termination is a priori outside
section 401 and is in settlement of a discrimination claim rather than earnings
under section 62 ITEPA.
Care must be taken in negotiating
settlements involving global sums which are not allocated to particular heads
of claim and ET Awards following a similar global approach may also prove
problematic especially where there are multiple causes of action and a
termination of employment.
At the heart of the disagreement
between the employment and tax experts is whether “injury” in particular
context of section 406 is wide enough to encompass injury to feelings so that a
termination payment, which is caught by section 401, is nonetheless exempted by
The Upper Tribunal placed great
emphasis on Horner in its analysis
of section 406, whilst noting that Hornerwas concerned with the predecessor provision in section 188(1)(a) ICTA. Section
406 ITEPA is said to be an exception for death or disability payments and
benefits, which does not perhaps lend itself quite so readily to “injury to
feelings”, but there may yet be some mileage in the points articulated by Singh
J in Timothy James (paragraph 67), in
seeking to distinguish Horner which
focuses on the meaning of “disability” rather than “injury” and in
circumstances in which the reasoning is obiter.
Post Moorthy it may be that the number of discrimination claims which
now actively plead pre-dismissal acts of discrimination or a claim in personal
injury arising from discrimination increases.
Perhaps more saliently, we all await
the results of the recent consultation by HMRC on the treatment of termination
and other employment payments:
Eleena Misra is the Employment Law Lead to the Law Reform
Committee of the Bar Council and responded to the HMRC Consultation on behalf
of the Bar Council together with a specialist tax adviser. She is regularly
instructed in high value discrimination claims including those involving
personal injury and is ranked in the directories as a leader in Employment
& Equalities Law.
Recent lectures include: Employment and Personal Injury at
the Intersection and Senior Executive Remuneration: Variable Pay.
Recent Publications: Blackstones Employment Law Practice
Eleena is joint Head of Professional Discipline at Littleton