The treatment of discrimination compensation has always been difficult to navigate, but a new decision of the First Tier Tribunal in Mr A -v- HMRC 2015 has made things still more confusing.

Mr A was a trader at a bank and he claimed to have suffered racial discrimination when his yearly bonuses were lower than he expected.  When Mr A was subsequently made redundant, he entered into a compromise agreement for which he was paid £600,000 to settle all claims.  HMRC taxed the payment as earnings, principally based on the fact that the payment was related to an alleged underpayment.  Mr A appealed.  

The tribunal held that in order for a payment to be taxed as general earnings (under s62 ITEPA 2003), it must be a reward for services past, present or future.  A payment as recompense for the right not to be discriminated against was not a reward for services.  The tribunal further held that it was not necessary to determine whether the employee had actually suffered any discrimination, or whether any claim for discrimination would have been successful. It was sufficient that the payment was made to the employee to settle the threat of a potential discrimination claim.  

HMRC advanced no argument that the payment should be taxed under s401 (as being in connection with Mr A’s termination) and as a result, if the general earnings charge (under s62) did not apply, the payment was not taxable.

This decision appears to depart from what has been understood to be HMRC’s practice and therefore, the only prudent approach now is to try to seek guidance from HMRC on settlement payments made in these circumstances.  This is particularly so given that differently constituted tribunals (in Walker 2003 and Oti-Obihara 2010) both decided that compensation payments for termination due to discrimination that are calculated by reference to loss of earnings are taxable under s401 ITEPA 2003.

The obvious alternative is for employers to deduct tax from any payment of this type and then leave the employee to apply for a reclaim of tax from HMRC later.

It is widely recognised that the taxation of compensation on termination is far too complex and HMRC launched a consultation on possible reforms earlier this year.  Further clarification in this area is to be welcomed, but the mixed messages coming from the tribunal are no substitute for clear and specific legislative provisions.