Taxation of payments for “injury to feelings”

29 January 2016

Moorthy v Commissioners for HM Revenue and Customs

The Tax and Chancery Chamber of the Upper Tribunal (TCC) held a sum paid to an employee under a settlement agreement in respect of injury to feelings was not exempted from income tax under S.406 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA). The Employment Appeal Tribunal’s decisions to the opposite effect in Vince-Cain v Orthet Ltd and Timothy James Consulting Ltd v Wilton 2015 ICR 764 were wrongly decided.

The issue surrounds the definition of “injury” in S.406 of ITEPA. S.406 takes payments made to employees in respect of injury outside the charge to tax.  TCC held that ‘injury’ did not include injury to feelings.

Following the start of Employment Tribunal proceedings for unfair dismissal and age discrimination, M was paid ‘an ex gratia sum of £200,000 by way of compensation for loss of office and employment’. On his tax return, M treated the whole sum as being tax free on account of “injury”. HMRC disagreed. On appeal, the First-Tier Tribunal (FTT) found that the whole of the settlement sum had been paid in connection with the termination of M’s employment under S.401 ITEPA and so was chargeable to tax pursuant to S.403 (£30,000 tax free and the balance charged to tax). M appealed against that decision to the Upper Tribunal. His argument that pursuant to S.406(b) ITEPA, the settlement sum was not taxable (i.e. it was paid on account of injury) failed.

The Upper Tribunal dismissed the appeal. It agreed with the FTT that the entirety of the £200,000 settlement sum fell within S.401 as a payment made in connection with the termination of M’s employment. The scope of this section includes non-pecuniary awards, such as damages for injury to feelings. Even where the sum paid exceeds the statutory maximum that could be awarded for unfair dismissal, that did not mean that the excess was unconnected with the termination of the employment.

As for the exemption in S.406, the Tribunal could not accept that even if a sum represented damages for injury to feelings, it was a payment on account of ‘injury’. The meaning of ‘injury’ in S.406 ITEPA is context-specific. It could not be read as exempting all payments made by an employer in respect of an injury to an employee; rather, it was intended to apply to injuries that led to the termination of employment or to a change in duties or level of earnings.

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