Introduction

The case of Mr A v. Revenue & Customs (2015) addresses the tax implications of a substantial settlement payment received by an employee from an employer. Specifically, it examines whether a £600,000 payment made under a compromise agreement was taxable as earnings under Section 62 of the Income (Tax Earnings and Pensions) Act 2003 (ITEPA 2003). The appellant, Mr. A, a Managing Director at a European bank in London, disputed HMRC's classification of this payment as taxable employment income, arguing instead that it was compensation for a threatened race discrimination claim. Additionally, Mr. A appealed against a careless inaccuracy penalty related to the omission of redundancy payments in his self-assessment tax return.

Summary of the Judgment

The First-tier Tribunal (Tax Chamber) concluded that the £600,000 settlement payment was not taxable as employment earnings under Section 62 ITEPA. The Tribunal determined that the payment was made in settlement of a threatened race discrimination claim, thereby categorizing it as non-earnings compensation rather than remuneration for services. Consequently, HMRC's amendment to Mr. A's self-assessment for the tax year 2008-9 was overturned. However, the Tribunal upheld the inaccuracy penalty of £739.72 related to the omission of redundancy payments, deeming the error to be careless.

Analysis

Precedents Cited

The Tribunal relied on several key cases to inform its decision:

• Deeny v Gooda Walker Ltd [1996]: Established that damages calculated by reference to income do not inherently constitute taxable earnings.
• Walker v Adams [2003]: Differentiated between compensation for injury to feelings and loss of earnings, treating the latter as taxable under termination payment provisions.
• Oti-Obahara [2010]: Reinforced that compensation for financial loss due to termination related to discrimination is taxable under specific sections of ITEPA.
• AB v HMRC [2011]: Indicated that HMRC may accept certain compensation payments for discrimination as non-taxable, though not establishing a definitive legal precedent.
• Hochstrasser v Mayes [38 TC 673] and Shilton v Wilmhurst [64 TC 78]: Provided foundational tests for determining whether a payment is a reward for services.

These precedents collectively shaped the Tribunal’s understanding of how compensation payments should be treated for tax purposes, particularly distinguishing between taxable earnings and non-taxable compensation based on the purpose of the payment.

Legal Reasoning

The Tribunal’s primary legal question was whether the £600,000 payment fell under the definition of "earnings" as per Section 62 ITEPA. Section 62 outlines earnings to include salary, bonuses, and other remuneration, but excludes payments not directly linked to the provision of services.

Mr. A contended that the payment was compensation for prospective race discrimination, not for services rendered, aligning with the principle that such compensation should not be classified as earnings. HMRC argued that any components of the payment related to past bonuses should be taxable.

The Tribunal examined whether the settlement was primarily a result of a discrimination claim. Evidence suggested that the payment was indeed made to settle this claim, as there was no admission of liability, and the settlement included sums that were not separately addressed in the agreement. The absence of witnesses from the Bank and the timing of the payment relative to the race discrimination questionnaire further supported the notion that the payment was aimed at resolving a discrimination issue rather than rectifying earnings.

Thus, the Tribunal concluded that the settlement was made to compensate for the threatened discrimination claim, rendering the payment non-taxable as employment earnings.

Impact

This judgment clarifies the distinction between taxable earnings and non-taxable compensation in the context of settlement payments for discrimination claims. Future cases involving similar settlements may reference this decision to argue against the classification of settlement amounts as taxable income, provided the settlement is clearly related to discrimination claims.

Additionally, the case underscores the importance of accurately reporting redundancy payments to avoid penalties. While the settlement payment's tax treatment was beneficial to Mr. A, the failure to correctly declare redundancy amounts led to a penalty, highlighting the necessity for meticulous tax reporting.

Complex Concepts Simplified

ITPA 2003 Section 62

This section defines what constitutes "earnings" for tax purposes, including salaries, bonuses, and other remuneration received in the course of employment. It excludes payments not directly related to employment services, such as certain compensation settlements.

Compromise Agreement

A legal contract reached between an employer and an employee where both parties agree to settle outstanding claims without admission of liability. It typically includes compensation and a clause releasing both parties from further claims related to the employment.

Careless Inaccuracy Penalty

A financial penalty imposed by HMRC when a taxpayer makes an error in their tax return due to lack of reasonable care, even if it was not intentional. The penalty amount depends on the severity and nature of the inaccuracy.

Adverse Inference

A legal principle allowing a tribunal or court to draw negative conclusions from one party’s failure to provide evidence or respond adequately to inquiries, implying that the missing information might be unfavorable to that party’s position.

Conclusion

The judgment in Mr A v Revenue & Customs (2015) establishes a critical precedent in the tax treatment of settlement payments related to discrimination claims. By recognizing that such payments, when made to settle discrimination claims, do not constitute taxable employment earnings under Section 62 ITEPA, the Tribunal provides clarity for both taxpayers and tax authorities. Employers must carefully consider the nature of settlement payments and their tax implications, ensuring accurate reporting to avoid penalties. This decision also highlights the Tribunal’s role in interpreting tax law in the context of employment disputes, balancing legal definitions with the practical realities of employment litigation.