Compensation payments and employment income: drawing the line

The First-tier tribunal decides on whether a payment to a non-salaried judge in respect of historic underpayments of his fees was compensation or taxable as employment income in Pettigrew v HMRC.

25 June 2018

Background

Mr Pettigrew sued his employer, the Ministry of Justice, for discrimination against part time employees. Mr Pettigrew and the Ministry of Justice reached an agreement pursuant to which Mr Pettigrew received payment for a historic underpayment of his fees of £55,045 inclusive of interest.

PAYE of approximately £22,000 was deducted from that lump sum payment. Consequently in his 2014-15 self-assessment tax return, Mr Pettigrew argued that the deduction of tax was incorrect since the amount paid represented damages for the statutory tort of breach of the Part-time Workers (Prevention of Less Favourable Treatment) Regulations 2000.

Arguments

Nearly 40 cases were cited to the First-tier Tribunal (FTT) from Henry v Foster (1932) to Miller & others v Ministry of Justice (2017).

Mr Pettigrew sought to argue that the compensation payment was not taxable as employment income, and instead should be considered damages for breach of the statutory tort, on the following grounds:

  • There was no contractual entitlement to the lump sum payment.
  • The payment was for discrimination under the Part-time Workers (Prevention of Less Favourable Treatment) Regulations 2000 and therefore compensatory in nature. It was also unconnected from any termination of his employment.

 Mr Pettigrew sought to rely on the case of A v Commissioners for HMRC, an FTT case where compensation for loss of earnings arising from discrimination was not taxable as earnings but was instead compensation for the employer’s breach of statutory employment rights.

HMRC sought to rely on the principle in Kuehne & Nagel Drinks Logistics Ltd, Scott and Joyce v HMRC that a payment was taxable as earnings where the employment was a substantial cause of the payment. The FTT also relied on  Miller & others v Ministry of Justice where it was held that lump sum payments made to employees represented amounts that the employees were entitled to for work carried out in previous years. The payments were still taxable as income and it was not considered relevant whether the payments were made at a later date.

The decision

The tribunal held that the fact that the payment of the lump sum to Mr Pettigrew was not contained in his contractual terms and conditions did not (in itself) prevent the payment from being in relation to his employment.

Similarly, the receipt of the lump sum in a settlement of litigation also did not prevent the sums being received in connection with his employment and taxed accordingly (as per the Court of Appeal decision in Hamblett v Godfrey).

The tribunal dismissed Mr Pettigrew’s arguments in relation to A v Commissioners for HMRC and held that the judgment was specific to the facts of the case. Instead the methodology and quantification of the lump sum was to remedy the underpayments made to Mr Pettigrew between April 2010 and December 2012 under his contract of employment. On this basis, the employment was held to be a sufficiently substantial reason for the payment of the lump sum.

Significance

This will be considered an important win for HMRC. HMRC disagreed with the judgment in the case of A v Commissioners for HMRC and, while not considered to be binding authority as an FTT decision, it is a useful outcome for HMRC to show that lump sum payments as part of a settlement agreement can constitute employment income.

How can Burges Salmon help?

If you have any questions or would advice relating to tax matters, please contact the key contact above.

Key contact

Suzanna Harvey

Suzanna Harvey Partner

  • Private Client Services
  • International Tax
  • International Trusts

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