Tax treatment of payment for in-work discrimination

The FTT has held that payments made to a former employee under a compromise agreement that related to discrimination that they had faced in work were not subject to tax: L v HMRC [2024] UKFTT1044. The FTT decided that the payment was not for services performed by the employee, but rather by reference to the fact that they were deprived of the opportunity to perform their role to the full.

Background

The taxpayer was employed as an executive director in return for a salary and discretionary bonus and deferred compensation under a long term incentive plan. In 2013 the taxpayer was made redundant and filed a claim before the Employment Tribunal alleging discrimination, unfair dismissal and inequality of pay. The in-work discrimination was particularised by reference to an unjustified bifurcation of their role, being side-lined, deprived of access to opportunities to develop business and unfair allocation of revenues between the taxpayer and colleagues when setting bonuses.

Following negotiations, the taxpayer accepted a compromise involving the payment of a sum £X, £Y in consideration of the waiver of all future claims and an agreement to treat termination as not involving a cancellation event for the purposes of the vesting of long-term incentive rewards. The employer made no admission of liability.

The taxpayer submitted a tax return on the basis that the parts of the compromise payment relating to deferred cash payments and share incentives were subject to tax but the remainder of the payment was outside the charge to tax. Following an enquiry into the return, HMRC considered that the whole amount was subject to tax, subject only to (a) the £30,000 tax free sum and (b) a sum for injury to feelings. In particular, HMRC’s assessment was made on the basis that the balance of the payment after deducting these amounts and an amount for compensation for termination of employment (ie essentially the balance of the payment attributed to the financial loss suffered as a result of the discriminatory actions of the employer) was taxable as income “from employment” taxable under ITEPA 2003 s.62.

FTT decision

The FTT noted that HMRC accepted in this case that, notwithstanding there being no admission of liability by the employer, that the total sum paid under the compromise agreement was not a global undifferentiated sum. HMRC accepted that, in addition to the taxable payments in respect of the long-term and share incentives, the payment included amounts for unfair dismissal, injury to feelings, unequal pay during the employment with the balance being in respect of discrimination suffered during the employment.

As a result, the FTT considered the taxation of each of the amounts in turn.

The payments in respect of long-term and share incentives were clearly in respect of amounts already earned by the taxpayer and, notwithstanding the fact that they were paid post-termination and subject to a settlement agreement, they remained taxable as income under s.62 (as such the taxpayer had been wrong to treat these payments as termination payments subject to the £30,000 tax free amount).

It was also accepted that payments received in consequence of breach of the equal pay legislation were fully taxable under s.62 as they represented the taxpayer’s right to be paid for the services performed under their contract of employment.

The part of the payment attributable to unfair dismissal and discrimination as part of the redundancy process was taxable in accordance with s.401 as a termination payment, subject to the £30,000 tax free allowance.

Finally, the FTT turned to the balance of the payment which was accepted to be for discrimination suffered by the taxpayer during the employment. The taxpayer argued that this payment whilst connected with the employment was not “from employment”. The taxpayer argued that whether a payment is “from employment” is essentially a question of whether the payment is a reward for services, past, present or future. On the facts of this case, the taxpayer argued that the discrimination payments were not “from employment” as they were deprived the opportunity to perform their services and the payment could not, therefore, be for services as such services were never performed. The taxpayer relied on A v HMRC [2015] UKFTT 189 where the FTT accepted that a payment made by way of compensation for loss suffered as a consequence of discrimination was not “from employment”. The FTT in that case suggested that if the question “why did the employee receive the payment” were posed, then the answer would not be it was in return for services but because the employer acted unlawfully by discriminating against the employee.

HMRC argued that the FTT decision in A v HMRC was wrongly decided and pointed out that that it had been doubted in the later case of Pettigrew v HMRC [2018] UKFTT 240. In addition, HMRC contended that when account was taken of the claims documentation it was clear that the taxpayer sought to recover sums of employment income to which they were properly entitled had the employer not acted unlawfully and, as such, they were sums ultimately paid for the services actually rendered in the course of employment. This was not a case where the only connection to earnings from employment was the basis on which the quantum of the claim had been determined, as might be the case in a personal injury claim. The fact that a claim had needed to be brought in order to secure the payment of sums to which the taxpayer was entitled did not alter the analysis of the source of the sums paid.

In this case, the FTT agreed with the taxpayer. The FTT noted that the payment for general discrimination related to the appointment of a second executive director thereby bifurcating the taxpayer’s role, resulting in lost opportunities. The FTT considered that to be a reason which was other than “from employment” because “the heart of this part of the Appellant’s claim is not that they were not fairly paid for what work they did but that they were deprived of the opportunity to perform their full role. Consistent with the analysis and description of the nature of a redundancy payment in Mairs compensation for such lost opportunity cannot be directly connected to the employment as it was an employment she never fulfilled because of the discrimination she experienced”. The claim was for damages for the detriment unlawfully caused to the taxpayer’s prospects and ability to perform the duties for which they considered they had been employed. They were not rewarded, through this payment, for services they did perform or would ever perform.

The mere fact that the measure of the damage was the financial loss caused cannot create the necessary causal connection between the payment and any services rendered by the taxpayer. It was also clear that whilst the taxpayer would not have received the payment had she never been employed by the employer, a “but for” test is not sufficient. The payment must be a reward for services.

As a result, the FTT held that the payment received by the taxpayer for general discrimination suffered during the employment was not subject to tax under s.62. Since HMRC had not argued that the payment was otherwise taxable (HMRC had not argued that it was taxable as a payment in connection with termination), the payment fell outside the scope of income tax.

Comment

It is perhaps surprising that HMRC were willing to accept that the payment made in this case could be clearly allocated between various heads of loss where it appears that the compromise agreement in this case contained no specific allocation other than to the long-term incentive and share elements. The remainder of the payment appears to have simply involved an undifferentiated settlement payment where the employer made no admission of liability for discrimination.

It also seems surprising that HMRC did not argue that the payment in respect of in-work discrimination was, in the alternative, subject to tax under s.401 as a termination payment. Section 401 is extremely widely drafted and will apply to any payments made “otherwise in connection with” termination of employment. In the recent Upper Tribunal decision of Mathur, it was held that a global settlement sum reached after negotiation and in return for withdrawing Employment Tribunal appeals based on the termination and other discriminatory treatment was clearly made both indirectly in consequence of and in connection with the termination.

More generally, however, there are now two FTT decisions concluding that a payment for in-work discrimination suffered by an employee which is not specifically for equal pay rights, but for broader lost opportunities to within the employment is not “from employment” in the context of the charge to income tax under s.62.