The decision in Moorthy v HMRC  UKFTT 834 (TC) confirms that a termination payment that includes an element related to discrimination and injury of feelings will be taxable under section 401 where the discrimination arises from the termination itself.
Section 401 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) charges to income tax payments and other benefits received directly or indirectly in consideration of, in consequence of, or otherwise in connection with the termination of a person's employment. The first £30,000 of such payment is generally free from income tax.
Mr Moorthy was made redundant in March 2010. He believed his former employer had discriminated against him on the grounds of age and took steps to take his case to the employment tribunal. The ensuing mediation proceedings resulted in Mr Moorthy receiving £200,000 as compensation for loss of office and employment. £30,000 of this payment was treated as tax-free with the remainder subject to income tax at 20%.
Mr Moorthy included the payment in his tax return, believing that the full £200,000 should have been tax-free. In the spirit of reaching an agreement, HMRC offered to treat £60,000 – the first £30,000 plus an additional and equal amount - as exempt. Mr Moorthy appealed, stating again that the full amount should be tax-free.
The tribunal noted that section 401 was very widely drawn, and found that, "whether or not any part of the payment was also to compensate [the taxpayer] for discrimination, unfair dismissal, injury to feelings, redundancy and/or financial loss was immaterial" because the fact that the payment was in connection with the termination of employment meant that it fell within Section 401 and was taxable.
The Tribunal rejected the argument that the payment had been made for the events leading up to Mr Moorthy’s dismissal rather than the dismissal itself. The Tribunal doubted whether in fact Mr Moorthy had suffered any injury to feelings before he was advised that he was at risk of redundancy and in so far as he had suffered such injury, this was attributable to the dismissal.
The judge also ruled that the first £30,000 exemption that HMRC had allowed in full should be reduced to take account of the statutory redundancy payment of £10,640 received by Mr Moorthy. Furthermore, the additional £30,000 allowance offered by HMRC was "an unlawful concession" that the tribunal could not take into account. Mr Moorthy therefore found himself in a worse position than if he had accepted HMRC's earlier offer.
The tribunal's decision is unsurprising and emphasises that where the alleged discrimination is the act of termination itself, the payment will, almost inevitably, be connected with the termination and taxable as a termination payment. This must be distinguished from a claim for discrimination that is unconnected with the termination where the damages will be tax free.