The Special Commissioner has held that a payment made to a former employee was chargeable to tax as a termination payment under section 401 of the Income Tax (Earnings and Pensions) Act 2003.

The employee in question had resigned when faced with internal disciplinary proceedings relating to alleged breaches of compliance rules. He brought a tribunal claim claiming compensation for injury to feelings as a result of being subjected to a detriment for having made a protected disclosure and also compensation for loss of earnings and damage to reputation by reason of his dismissal. His claims were settled by a payment of £250,000 from his employer that was stated to be "in respect of the employment tribunal claims".

The employee failed to re-establish his career in the financial sector and argued that £200,000 of the payment was for loss of reputation and injury to feelings and therefore not subject to tax. The Special Commissioner, applying the well-known guidelines from the Vento case, held that only £10,000 could be attributed to injury to feelings. The balance related directly or indirectly to the termination of employment and was taxable under section 401, meaning that only the first £30,000 was exempt from tax. The terms of the settlement agreement were of critical importance in arriving at this decision.

Impact on employers

Section 401 ITEPA will apply to most compensation payments negotiated with departing employees. Employers should ensure that they properly assess and describe the nature of any compensation payments made to employees and ensure consistency between the terms of any settlement agreement and the arguments which the parties wish to put to HMRC in respect of income tax.