The recent Tax tribunal case of Moorthy v HMRC considered the well-known Section 401 ITEPA 2003 which, together with Section 403, makes taxable payments over £30,000 which are directly or indirectly in consideration of the termination of employment. It also looked at the rules allowing compensation for injury to feelings caused by unlawful discrimination to be paid without tax. 

Mr Moorthy had been made redundant and received a payment of £200,000 from his employer under a compromise agreement. The question was around the tax treatment of that payment. Mr Moorthy argued that the £200,000 was a payment to settle an alleged discrimination claim arising during the redundancy selection process as well as to compensate Mr Moorthy for injury to feelings, therefore following the prior first tier tribunal case of Oti-Obihara v HMRC which held that as the discrimination was the cause of the termination the compensation payment should be fully exempt. In the preliminary skirmishing by correspondence HMRC disagreed but as a concession offered to allow Mr Moorthy a very generous £30,000 under the tax free injury to feelings head on top of the £30,000 exempt from tax under Section 403 (“very generous” because such a figure would only be awarded by the Employment Tribunal in the most extreme cases). Mr Moorthy declined that offer.

Judge Redstone in the First Tier Tribunal was not convinced by his arguments and decided that the secondary purpose of the payment, i.e. to compensate Mr Moorthy for discrimination or other financial loss, was irrelevant and so the whole of the payment plainly fell within the terms of Section 401 as made in consideration for the termination of Mr Moorthy’s employment. The Tribunal did not consider that there had been any discrimination (though it is clear from the size of the payment made – not including Mr Moorthy’s notice entitlement – that his former employer was more than a little jittery on the point), and so did not regard itself as bound by the concession offered in correspondence.

Mr Moorthy was still entitled to the £30,000 exemption under Section 403. However during the course of the Tribunal proceedings it was discovered that HMRC had in fact miscalculated the amount eligible for the £30,000 exemption as they had failed to consider the £10,640 statutory redundancy payment also made to Mr Moorthy, leaving him with less than £20,000 to benefit from the exemption and not the £30,000 he had thought. Overall he was substantially worse off than had he accepted HMRC’s offer. 

The moral of the story? Two-fold: first, don’t assume that just alleging discrimination will get you a chunk of your severance pay tax-free. Second, don’t assume that an HMRC concession will be there forever – they are not offered lightly and HMRC will have no compunction about pulling them.