Compensation payment not taxable

08 June 2009

Employee Incentives & Benefits Group

A tribunal judge found a payment for failure to follow proper procedures was not connected to termination of employment and so was tax free.

Summary of Crompton v Revenue & Customs [2009] UKFTT 00012 (TC)

Mr Crompton was in the Royal Engineers and moved to the REME, the post was civilianised but rather than take redundancy he applied for five posts with the Army for which he was qualified.  Army rules entitled him to be given priority over other applicants but the Selection Board rejected all five applications.  Mr Crompton then took a job as a storeman for a few months and then took voluntary redundancy from that post.  

After many years the Army Board awarded compensation for its failure to follow proper procedures in relation to the five applications. 

The tribunal held that the compensation payment was not connected with the termination of his employment as a storeman and so was tax free. 

Taxation of termination payments
 
Termination payments are taxable under s401 ITEPA 2003 if no other charging provision applies.  The other charging provisions are:

  • S62 ITEPA (general earnings)

  • S225- 226 ITEPA (consideration for restrictive covenants)

  • S394 ITEPA (employer-financed retirement benefit schemes)

If s401 applies, the first £30,000 is tax free and the whole payment is NIC free.  Normally one tries to show a payment is taxable under s401 as payments caught by the other provisions are fully taxable and NICable. 

Occasionally it is possible to show both that a payment is not taxable under the other provisions or s401 and so entirely tax and NIC free. 

Section 401 is widely drafted and applies to payments received directly or indirectly in consideration of or in consequence of or “otherwise in connection with” termination of employment. 

Payments for injury to feelings are one example of payments outside s401 but the payment must relate to discrimination which occurred before the termination. 

This case is another example of a payment outside s401.  Whilst there need not be a strict causal link between the termination and the payment there needs to be some link.  The circumstances of this case were unusual as Mr Crompton was helped by the fact that he remained in his job as a storeman for a few months and the reason for the payment was well documented. 

The judge rejected the argument of HMRC (put by Mr Death!) that there can be no loss without termination.  The case opens up the possibility of payments in settlement of losses for failure to promote being tax free.  

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