Compromise payment was not earnings

The First-tier Tribunal handed down its decision in the case of A v HMRC [2015] UKFTT 0189 (TC) on 5 May 2015, which serves to highlight the complexities surrounding the taxation of compromise payments made to employees after the termination of their employment.

Unusually, the case was anonymised on the basis that it would be unfair to the employer if the claimant and the employer were identified, as a key issue related to accusations of race discrimination made against the employer, which they would be unable to defend not being party to the proceedings.

Mr A had worked for a bank as the managing director of its Emerging Markets group.  While he worked there he had complained that his bonus payments were out of line with the financial results achieved by his group and those received by other members of the team.  Mr A alleged that, based on things that had been said to him by other members of management, his race was a primary reason for this disparity in his bonus payments; in consequence, Mr A’s solicitor served a questionnaire under the Race Relations Act on the bank in March 2008.

Later in March 2008, the bank made Mr A redundant and offered him a redundancy package comprising £1,650 in statutory redundancy pay and an ex-gratia payment of £48,898.  It subsequently offered Mr A an additional lump sum of £600,000 if he signed a compromise agreement.

HMRC argued that the additional lump sum was taxable employment income, as it constituted “earnings” within the meaning of s62 ITEPA 2003 (they accepted that this amount was not taxable under s401 ITEPA 2003, as it was not a payment received in connection with the termination of Mr A’s employment).  The basis for HMRC’s submission was that the £600,000 was calculated by reference to the lost bonuses and pay rises that Mr A believed that he had suffered and, as such, they should be taxed as earnings.

The tribunal took, as its starting point, the proposition that a payment made under a compromise agreement for a claim of racial discrimination should be treated in the same way as the award that could have been made by an employment tribunal deciding the same case.  In this case, any award made by an employment tribunal would have been in compensation for the breach of the right not to be discriminated against and not as a reward for services.

The tribunal held that there was adequate evidence to support the contention that the additional lump sum was paid by the bank to prevent litigation, rather than as a reward for services past, present or future, and that the payment could not be treated as “earnings” within the meaning of s62 ITEPA 2003.

For further information please contact the TaxDesk on 0845 4900 509 and ask for Thomas Dalby.