Good decision short-lived: Taxation of injury to feelings

There has been a long-running battle about the tax treatment of injury to feelings in settlement agreements and whether they are exempt from tax (under an exemption for payment relating to injury or a disability of an employee). In this case the Court of Appeal made a finding that injury to feelings does fall within the exemption and tax should not be payable on injury to feelings.

A payment was made to Mr Moorthy to settle claims for unfair dismissal and age discrimination following the termination of his employment by reason of redundancy. As part of his settlement he received £200,000 in financial compensation which was paid tax free on the basis that it was paid in connection with injury to Mr Moorthy's feelings. The main contention was that Section 406 of the Income Tax (Earnings and Pension) Act 2003 provided that no tax is payable on account of injury to an employee. However HMRC argued that injury to feelings fell outside this definition as the tax exemption was only intended to apply to compensation for personal injury as opposed to injury to feelings i.e. distress. In its finding the Court of Appeal confirmed with the recent tax changes that 'injury…includes psychiatric injury, [but] it does not include injured feelings’.

However this decision was short-lived due to the recent tax changes from 6 April 2018 highlighted in last month’s bulletin which confirms that "injury" in section 406 specifically includes psychiatric injury but expressly excludes injury to feelings.

What does this mean for you or your business?

The government has clarified that termination payments for injury to feelings will only be exempt if they relate to psychiatric injury or another recognised medical position. If there is no termination and you are making an injury to feeling payment then this can be made tax free subject to the guidance. For example, if an employee is still working for your business.

What do you need to be doing now?

Given that HMRC are cracking down on employers that contravene the new tax provisions, HR should be aware of the process and be trained in the new provisions, otherwise this could lead to naming and shaming, resulting in reputational and financial repercussions for your business.

These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.