Kerry Underwood


with 4 comments

In September and October I am delivering my new course – Getting the Retainer Right – in 10 cities – details and booking form here.

In Moorthy v Revenue and Customs [2018] EWCA Civ 847

the Court of Appeal held that compensation for injury to feelings paid in accordance with the terms of a Settlement Agreement is not taxable, as it falls within the exclusion from taxation of payments on account of “injury”.

Section 406 of the Income Tax (Earnings and Pensions) Act 2003 provides that a payment or other benefit provided “on account of injury to… an employee” on the termination of a person’s employment is not subject to income tax.

The issue here was whether a settlement in reference to a claim for injury to feelings, amongst other things, was subject to income tax or was excluded as coming within the definition of “injury”.

In holding that injury to feelings is indeed a species of injury exempting that part of the payment from tax, the Court of Appeal has resolved differences of opinion in the lower courts on this point.

Broadly the Employment Appeal Tribunal had held that injury to feelings awards are in relation to “injury” and are tax free – see for example: 

Orthet Ltd v Vince-Cain [2004] IRLR 857;  and

Timothy James Consulting Ltd v Wilton [2015] IRLR 368

whereas the Tax Tribunals, as here, have held such payments liable to tax as not being in respect of an injury.

Here the Court of Appeal applied the Vento guidelines so as to exempt £30,000 from tax, even though that meant treating the balance of £170,000 as effectively compensation for unfair dismissal, even though that sum vastly exceeded the maximum statutory compensation for unfair dismissal.

There is a sting in the tail in relation to this issue, apparently now clarified by the Court of Appeal.

Section 5(7) of the Finance (No 2) Act 2017 has inserted, with effect for the tax year 2018/19 onwards, a new subsection (2) to section 406 of the Income Tax (Earnings and Pensions) Act 2003, which reads:

“Although “injury” in subsection (1) includes psychiatric injury, it does not include injured feelings.”

Thus there is now no doubt that awards and settlements for injury to feelings are subject to income tax, certainly on the termination of employment.

Presumably Employment Tribunals must now gross up awards so that, once income tax has been deducted, the employee is left net with the Vento guidelines sum.

Thus if the Employment Tribunal believes £30,000 to be the correct Vento sum, and the taxpayer is subject to 40% tax, then the award must be increased to £50,000, so that the employee actually gets £30,000 net of tax.

That view is supported by the decision in Orthet where the Employment Appeal Tribunal specifically considered the issue as to whether the injury to feelings award had to be grossed up to ensure that the employee received £15,000, the sum awarded by the Employment Tribunal on the assumption that it would not be subject to income tax in her hands.

The Employment Appeal Tribunal held that the Employment Tribunal had been correct in that assumption and therefore there was no need to gross up as no income tax was payable in any event on that element of the award.

The assumption was that if the award was to be subject to income tax, then it would have had to be grossed up to leave the employee with the correct Vento sum in her hands, net of tax.

Employees in the past who have paid income tax on injury to feelings payments should now get a refund from HMRC.

Section 406, now amended, is part of Chapter 3 of Part 6 of the Income Tax (Earnings and Pensions) Act 2003, which chapter is headed:

“Payments and Benefits on Termination of Employment etc.”

Thus it appears that awards for injury to feelings other than on termination remain free of income tax, which does not seem logical.

It also raises the issue of whether an employer and an employee can agree, shortly before actual termination, an injury to feelings award so as to avoid it being subject to termination income tax.

Written by kerryunderwood

September 14, 2018 at 8:30 am

Posted in Uncategorized

4 Responses

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  1. thanks Kerry

    This is a very informative post

    Richard Gray

    September 15, 2018 at 9:44 pm

  2. One thing to do when a Defendant accepts an offer 6 months down the line is wait until the insurer has failed to make payment within 14 days and then apply for Judgment under CPR 36.14(7). It won’t work if the insurers send payment when accepting the offer but few do and receiving the payment within 14 days of acceptance is something which never happens in low value cases. Once you have a Judgment you should surely get costs on the basis your client now has a money judgment equal to an offer they made some time ago.

    Lisa Amey

    September 17, 2018 at 2:05 pm

    • True, but it depends on the court entering judgment reasonably quickly………….


      September 17, 2018 at 5:10 pm

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