The income tax and national insurance treatment of termination payments under Part 6 ITEPA 2003. Mairs v Haughey; Moorthy v Revenue and Customs.
Damages; taxation; the Gourley principle. The House of Lords held that damages for loss of earnings must be assessed on a net-of-tax basis: the claimant is entitled only to the net sum they would have received after tax, not the gross pre-tax figure. To award gross earnings as damages would over-compensate the claimant, since the lost earnings would themselves have been subject to income tax had they been earned. The principle applies wherever the lost income would have been taxable and the damages themselves are not. In employment tribunal proceedings, Gourley underpins the obligation to gross up awards where compensation will be taxable on receipt, working from the intended net figure back to the gross sum needed to produce it.
Taxation; termination payments; the House of Lords held that a non-contractual termination payment is not taxable as an emolument under what is now s.62 ITEPA 2003 because it is not paid for services rendered but rather as compensation for not being able to continue earning a living from the former employment. The payment falls instead within what is now s.401 ITEPA (subject to the £30,000 exemption). A foundational authority on distinguishing earnings from termination payments.
Compensation; taxation; injury to feelings. An award for injury to feelings in a discrimination claim not connected with the termination of employment falls outside s.401 ITEPA 2003 and is not taxable, so is not grossed up. Note that s.406(2) ITEPA 2003, as amended by Finance (No. 2) Act 2017 s.5(7) with effect from 2018/19, now provides that although 'injury' includes psychiatric injury it does not include injured feelings; injury to feelings connected with the termination is therefore within the charge, subject to the £30,000 threshold. Moorthy v HMRC [2018] EWCA Civ 847 decided the contrary for pre-amendment years only and should not be cited for the current position.
Pre-Finance Act 2017 authority on the tax treatment of injury-to-feelings awards connected with termination. The Court of Appeal held that a payment genuinely referable to personal injury (including discrimination-related hurt) could fall within the s.406 ITEPA 2003 exemption. The Finance Act 2017 subsequently excluded injury-to-feelings awards connected with termination from that exemption for payments from April 2018 onwards, making such awards fully taxable within the s.401 regime above the £30,000 threshold.
A £1,055,000 settlement of an ET claim for sexual harassment included confidentiality and non-disclosure obligations. The FTT held the payment was a restrictive undertaking within s.225 ITEPA 2003, not a termination payment under s.401: the entire sum was taxable as employment income with no £30,000 exemption, and subject to employees' NI. A cautionary authority: including NDA obligations in a settlement agreement risks HMRC recharacterising the payment as a restrictive undertaking, stripping the recipient of s.401 relief entirely.