Two recent cases have highlighted the need for employers to carefully follow the written terms of a compromise agreement when deciding how much tax should be deducted at source.

Norman v Yellow Pages

In Norman, Ms Norman brought employment proceedings against her former employer. A compromise was reached and the employer agreed to pay £53k compensation in settlement of all claims. No apportionment was made for injury to feelings. The employer considered that the fi rst £30k should be paid free of tax but deducted £5,350 from the remainder on the basis that it was necessary to deduct basic rate tax and NICs at source from settlement sums in excess of £30k. Ms Norman then brought proceedings in the district court seeking to recover the £5,350 from her former employer and claiming that her former employer was in breach of an obligation to make a fair apportionment.

The claim was dismissed at fi rst instance and on appeal. By the time it reached the Court of Appeal, HMRC had informed Ms Norman that it was prepared to accept that £30k should be apportioned to injury to feelings, which would not be subject to tax deduction and so resulting in a tax refund for her. Despite this, Ms Norman proceeded with her claim that her employer should have made a fair apportionment. The Court of Appeal held that there was no evidence that the parties had discussed apportionment before the compromise agreement was signed. In the absence of a term in the agreement there was no obligation on the employer to make an apportionment. This was especially the case when it was borne in mind that the employer had its own obligations to HMRC and that HMRC was not bound to accept an apportionment which it might consider had been framed to the employee’s advantage and its own disadvantage. The Court of Appeal pointed to the ability of Ms Norman to reclaim the disputed amount from HMRC, and dismissed the appeal.

Goldberg v HMRC

In Goldberg, the employee was similarly thwarted by the lack of precision in a compromise agreement. On the cessation of his employment, Mr Goldberg’s former employer had agreed to pay Mr Goldberg the sum of £76,872. This sum was paid with tax deducted from the whole amount. Mr Goldberg understood he was entitled to receive the fi rst £30k free of tax so completed his tax return on the basis that he was due a substantial repayment. HMRC considered the entire £76,872 as a Payment in Lieu of Notice (PILON) and amended Mr Goldberg’s tax return. Mr Goldberg appealed. At the hearing before the First-tier Tribunal Mr Goldberg claimed that his employer had been involved in negotiations regarding a take-over by a US company. That company would not be interested if it became aware of the involvement of Mr Goldberg or another employee, both of whom had previously been involved with a competitor to the US company. On that basis Mr Goldberg had agreed that his former employer could “dress up” his departure as redundancy.

The correspondence presented to the First-tier Tribunal was rather scant, with the contract of employment presented (by HMRC) being that of the other employee rather than Mr Goldberg. Mr Goldberg claimed that there was no provision in his contract of employment for a PILON, but was unable to provide evidence of what he said was his true contract of employment. Mr Goldberg was also unable to provide any evidence of the agreement he had reached with his former employer to dress up his cessation as redundancy. His offi cial letter of redundancy described the payment as a PILON.

In the circumstances it was perhaps inevitable that the First-tier Tribunal would fi nd that there was a PILON and that Mr Goldberg’s appeal would be dismissed.

Lessons to be learned

Both cases demonstrate the need for employers to be careful to follow the terms of the signed compromise agreement.  

It would have been easy for the employer in Ms Norman’s case to have made an apportionment even though there was nothing on the face of the agreement. But, had it done so, it could have resulted in further litigation with Ms Norman if she felt the amount apportioned was too parsimonious, and a potential dispute from HMRC if it considered the employer had been too generous. In the absence of an apportionment agreement, there is no obligation on an employer to make an apportionment between the taxable and non-taxable elements of an award.

In Mr Goldberg’s case, had the employer followed the terms of the undocumented side agreement, then it would have paid the fi rst £30k of damages to Mr Goldberg without deduction, and would almost certainly have subsequently found itself obliged to pay over to HMRC the tax which it should have deducted at source.

In all cases employers are also entitled to have regard to their own obligations to HMRC (and the risk that HMRC will challenge the amount deducted). In the overwhelming majority of cases the safest course for employers is to err on the side of caution, and allow the employee to make a claim to HMRC to recover any tax overpaid.