The First-Tier Tribunal (FTT) has held that a payment made by an employer to an ex-employee pursuant to a compromise agreement, in full and final settlement of a potential race discrimination claim, did not amount to taxable earnings.

The appeal concerned the payment of £600,000 to Mr A by the employer. The payment was made by the employer immediately following a race discrimination questionnaire being served on it. It was alleged by Mr A that he received unfair treatment in respect of bonuses and salary and the payment amounted to compensation for this unfair treatment. HMRC argued the payment made good shortfalls in bonus and salary payments due to Mr A for services he provided.

In considering the appeal the FTT looked at how damages awarded by an Employment Tribunal (ET) for discrimination would be treated for tax purposes where the discrimination manifested itself in the way an employee was remunerated. The key question was “Why did the employee receive the payment?” The FTT considered that in these circumstance the payment arose from the employee’s statutory right not to be discriminated against opposed to an underpayment for services. Recognising that the payment had been calculated by reference to under-paid earnings, the FTT was still of the view that the under payment itself was discriminatory and so could not be described as a reward for services.

The difficulty faced by the FTT, without an ET decision (and without being able to step into the shoes of the ET), was to determine if the payment related to an act of discrimination by the employer despite the appeal arising from the treatment of the payment by HMRC. The FTT recognised that it was unlikely for any employer to make an admission of liability to race discrimination in the context of a settlement agreement and equally that Mr A would not have to prove actual discrimination. Instead the FTT considered the likelihood of the payment being made to settle a potential claim against the bank for discrimination by looking at the conduct of the parties.

The FTT held that the payment was made to settle a claim for race discrimination opposed to making good any shortfalls and so was not taxable as employment earnings. In reaching this conclusion it is important to note that the FTT steered away from looking at what the payment actually represented, as HMRC had done, and instead focused on the reason for the payment being made by looking at the conduct of the parties and, crucially, the timing of the payment.