Termination payments and the disability exemption

The FTT has held that a payment made on account of ill health as part of a termination agreement falls within the exemption in ITEPA 2003 s.406 for payments “on account of injury to, or disability of, an employee: Howard-Ravenspine v HMRC [2023] UKFTT 471. The FTT rejected HMRC’s argument that for a payment to fall within the disability exemption, it must be paid on account of the disability and nothing else.

Background

The appellant worked for Norton Rose Fulbright as an IT testing team leader. From June 2012 she suffered from ill-health and had been in receipt of benefits under a permanent health insurance (PHI) scheme from December 2012. By 2016, the PHI provider was reluctant to continue paying benefits and following discussions with the employer, negotiations took place for the termination of her employment.

The termination agreement involved the payment to the taxpayer of around £108,000 including amounts in respect of accrued salary and untaken holiday. In particular, it included a severance payment of £93,000 as “compensation for loss of office”. Separate letters from her employer and the insurer made it clear that this severance payment was made up of £84,000 PHI claim payment to settle the ongoing PHI claim and £9.000 as a severance payment.

In 2019, the question of the correct tax treatment of the severance payment arose when HMRC sought to levy a high income child benefit charge (HICBC) on the taxpayer. The levying of this charge depended on whether the taxpayer had received in excess of £50,000 adjusted net income in 2016/17 and this in turn depended on whether the severance payment of £93,000 was taxable or whether it fell (in part) within the disability exemption in s.406(1)(b). The taxpayer argued that £84,000 of the payment clearly fell within the disability exemption and therefore did not form part of her adjusted net income. HMRC disagreed and assessed the taxpayer.

FTT decision

HMRC’s argument was based on the earlier High Court decision in Hasted v Horner [1995] BTC 343. HMRC’s interpretation of that decision was that for a payment to fall within the disability exemption it must meet two tests: (i) there must be an identified medical condition preventing the employee from carrying out the duties of the employment and (ii) the payment must be made on account of that disability and nothing else. In this case, whilst they accepted that there was a relevant disability, it was clear the payment had been made on account of and as compensation for termination of the employment.

The FTT rejected that analysis. The FTT noted that the decision of Lightman J in Horner v Hasted on the second part of the test was actually that “the person making the payments does so not merely in connection with the termination of employment… but on account of the disability of the employee. In short, there must be established as an objective fact a relevant disability and as a subjective fact that the disability is the motive for payment by the person making it.” HMRC had not correctly encapsulated those points in the Employment Income Manual (EIM) para 13630. There was no basis for treating the test as “all or nothing” such that if the severance payment is made on account of disability but also on account of other matters, the fact that some of the payment was made for those other matters meant that none of the disability payment could qualify for exemption.

The legislation must be construed purposively and the purpose of the disability exemption is to exempt from tax any payment made on account of a disability irrespective of whether other payments are being made to the employee as part of the same deal. “Clearly if a single payment is being made and it is not clear from the evidence, whether documentary or oral, the purpose for which a payment is made, it is perfectly acceptable for HMRC to deny the disability exemption given that the taxpayer will not have been able to establish that that payment was made on account of disability. But where, as in this case, the appellant has provided compelling evidence that a very significant element of the severance payment was on account of disability, then it is our view that that element benefits from the disability exemption even though the termination agreement states that the severance payment of £93,357 was a single payment paid as compensation for loss of office.”

Indeed, the FTT pointed out that EIM para 13637 appeared to accept this, stating that where a payment has been made for disability, sometimes the termination agreement may indicate other issues are being dealt with and so an apportionment may be necessary.

In this case, it was clear (from the agreement and from other documentation showing the breakdown of the payments) that the severance payment, although expressed to be paid as compensation for loss of office and termination was being made in part (£84,000) because of the appellant’s ill health. That payment fell within the disability exemption and so did not count towards the taxpayer’s adjusted income for the purposes of calculating the HICBC charge.

Comment

It seems disappointing in this case that not only did HMRC take an overly strict view of the requirements of s.406(1)(b), they did so disregarding the contents of their own Manuals (and having failed to refer the FTT to that part of the Manuals). In that context, the judgment provides important clarification of the position and it is to be hoped that HMRC amend the remainder of their guidance accordingly.

More generally, the decision also shows the importance of ensuring that the elements making up a termination payments are correctly and appropriately identified, ideally in the termination agreement itself, to avoid disputes with HMRC. It is only where an employee can meet the burden of proof of demonstrating that a payment on termination is made on account of disability that s.406(1)(b) can be relied on. As the tribunal indicated, a general, global payment made on termination without any detailed allocation is unlikely to qualify for the exemption even if in practice a medical condition was the root cause of the termination.