The claimant in Timothy James Consulting Ltd v Wilton was awarded £10,000 in injury to feelings compensation, having succeeded in a sex-related harassment claim. The tribunal grossed the payment up on the basis that it would be taxable. The employer appealed successfully in the EAT against the grossing up of the award. 

The EAT focused on the tax provision dealing with payments on disability or death.  This states that tax is not payable on a payment or benefit provided in connection with the termination of employment by the death of an employee, or "on account of injury to, or disability of, any employee". Having reviewed conflicting decisions on the point, the EAT took the view that "injury" in this context would include injury to feelings (as found by an earlier decision in Orthet Ltd v Vince-Cain).

There is a conflicting case which we covered last summer: in Moorthy v HMRC the Tax Tribunal found that a payment made to compromise an unfair dismissal and age discrimination claim, including any injury to feelings element, should be subject to income tax under the widely drawn provision (section 401) taxing termination payments, regardless of the reason for the payment, with the result that only £30,000 could be made on a tax free basis. But the EAT in Wilton preferred to rely onOrthet

This leaves employers in the problematic position of having contradictory decisions.  The cautious view is that, particularly where an element of injury to feelings is being paid on termination of employment, HMRC may seek to argue that any payment in excess of the £30,000 exemption should be subject to tax.

Where compensation is paid to reflect discrimination that was not connected to the termination of employment, this should not be taxable, but given the breadth of the wording of section 401, there may need to be cogent evidence separating the discrimination from the ultimate dismissal.