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Welcome Clarity Received on the Tax Treatment of Injury to Feelings Payments

  • United Kingdom
  • Tax planning and consultancy



In the recent case of Krishna Moorthy v HMRC [2016] UKUT 13 TCC, the Upper Tribunal (“UT”) has provided helpful clarity on the income tax treatment of injury to feelings payments made in connection with the termination of employment. 

The UT has confirmed that such payments fall to be taxed under section 401 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”), overruling the First Tier Tribunal decision in Oti-Obihara v HMRC [2010] UKFTT 568 (TC) which suggested that injury to feelings payments could always be paid free of tax.

In addition, the UT confirmed, following a detailed review of the case law in this area, that injury to feelings payments do not benefit from the “injury and disability” exemption set out at section 406 ITEPA, concluding that the reference to “injury” in section 406 is a reference to a medically recognised condition which does not include injury to feelings.  Until now this has also been an issue on which a number of Employment Tribunals have reached a different conclusion.


Mr Moorthy was made redundant by his employer in March 2010.  He received a statutory redundancy payment of £10,640 in the 2009-2010 tax year from which no tax was deducted. 

Mr Moorthy subsequently brought proceedings in the Employment Tribunal claiming unfair dismissal and age discrimination.  A compromise agreement was entered into, under which his employer agreed to pay an ex gratia sum of £200,000 by way of compensation for loss of office and employment. 

Mr Moorthy’s employer treated £30,000 of the settlement amount as exempt from tax by virtue of section 403 ITEPA and deducted income tax at the basic rate from the balance.  Mr Moorthy completed his self-assessment tax return for 2010-11 on the basis that the settlement amount was tax free.  HMRC did not agree with the position taken by Mr Moorthy and issued a closure notice amending Mr Moorthy’s self–assessment return accordingly.

Mr Moorthy appealed against the amendment to his return and, in a decision released in August 2014, the First Tier Tribunal found that:

(1)  the settlement amount of £200,000 fell to be taxed within section 401 ITEPA;

(2)  taking into account the statutory redundancy payment of £10,640 made in the 2009-2010 tax year, the £30,000 exemption allowed by section 403 ITEPA was reduced to £19,360; and

(3)  it had no jurisdiction to allow a further tax relief of £30,000, granted by HMRC on a concessionary basis in an attempt to reach a swift settlement with Mr Moorthy.

Key Issues and Judgment of the Upper Tribunal

Was the settlement amount a payment in connection with the termination of employment within section 401 ITEPA?

The UT considered that the language of section 401 ITEPA is clear and its scope is wide.  The UT confirmed that (i) the section applies to payments and other benefits that are received in consequence of, or otherwise in connection with the termination of a person’s employment and (ii) there is nothing in the terms of section 401 ITEPA that excludes non-pecuniary awards, such as damages for injury to feelings, from its scope.

In the UT’s judgment, damages to reflect non-pecuniary matters fall within section 401 ITEPA if they are connected with the termination of employment.  On this point, the UT specifically referred to the decision of Oti-Obihara v HMRC, holding that the First Tier Tribunal erred in distinguishing between non-pecuniary aspects of the award, such as injury to feelings, and pecuniary aspects such as financial loss, in determining whether a payment received in connection with the termination of employment falls within section 401 ITEPA.

Having considered a number of authorities on this particular point, the UT held that the settlement payment fell within section 401 and, under section 403, counted as employment income, subject to the £30,000 threshold.

Is the settlement amount subsequently taken out of the charge to tax by virtue of section 406 ITEPA?

The UT did not consider that section 406(b) ITEPA can be read as exempting all payments made by an employer in respect of an injury to an employee from tax under section 401.

The view taken by the UT was that the reference to “injury” within section 406(b) fell to be considered and interpreted in line with the reference to “disability” in that section which, in the leading decision in this area, Horner v Hasted (Inspector of Taxes) [1995] STC 766, was held to be a reference to a medically recognised condition which led to the termination of employment or to a change in duties or level of earnings.

Declining to follow a number of Employment Tribunal decisions, which the UT considered to be wrongly decided on this point, the UT concluded that injury to feelings do not amount to a medically recognised condition and accordingly any payment made in respect of injury to feelings fell outside of the scope of section 406(b). 

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