What are the Tax Implications of Settling an Employment Tribunal Claim?

When paying money to settle Employment Tribunal (ET) proceedings, employers are not infrequently motivated by a desire to make what they perceive as a nuisance go away – but how should such payments be treated for tax purposes? The First-tier Tribunal (FTT) tackled that thorny issue in a guideline case.

A senior bank employee was dismissed following a regulator’s investigation into an aspect of the bank’s business. She asserted that she had been made a scapegoat and thrown under a bus by a white male cartel at the bank. She lodged a number of complaints with an ET and, about a year after her employment was terminated, the bank settled her claim for £6 million. More than £2.6 million of that sum was deducted at source by the bank under the PAYE system.

She sought repayment of the latter sum, but HM Revenue and Customs (HMRC) asserted that all but £44,000 of the settlement figure had been correctly charged to Income Tax. Citing Section 401(1) of the Income Tax (Earnings and Pensions) Act 2003, it said that she had received the money indirectly in consequence of, or otherwise in connection with, the termination of her employment.

Challenging that decision, the woman contended that the settlement in large part reflected the strength of her moral, rather than legal, claim against the bank. So far as the bank was concerned, her claim had a nuisance value in that she had a story to tell about her treatment to the court of public opinion. The bank had a powerful public relations motive for settling the matter privately and, on that basis, the woman argued that any relationship between her dismissal and the settlement payment was coincidental.

The sum that she received did not appear as a termination payment in the bank’s accounts. Many of her complaints, particularly of discrimination, related to events some time prior to the termination of her employment. She also pointed to the lapse of time between her dismissal and the settlement agreement.

In rejecting her appeal, however, the FTT noted that, prior to her dismissal, she had shown deep reluctance to formally pursue a discrimination claim against the bank. The termination of her employment was the triggering event and catalyst for the employment proceedings and, in turn, the settlement payment.

It was her dismissal that enabled her to pursue a highly effective bargaining position vis-à-vis the bank. After positioning herself as a nuisance, she was able to negotiate the settlement payment as the price to make her go away. Such a negotiating stance would have been very difficult, if not impossible, to adopt had her employment not been terminated. The statutory test was therefore met and the settlement payment was properly taxed.