Settlement sum representing injury to feelings was taxable

In Moorthy v Commissioners for HM Revenue and Customs, the Tax and Chancery Chamber of the Upper Tribunal has held that a sum paid to an employee under a settlement agreement in respect of injury to feelings was not exempted from income tax under S.406 of the Income Tax (Earnings and Pensions) Act 2003. Although S.406 takes payments made in respect of injury to an employee outside the charge to tax, ‘injury’ in this context did not include injury to feelings. The EAT’s decisions to the opposite effect in Vince-Cain v Orthet Ltd (Brief 770) and Timothy James Consulting Ltd v Wilton 2015 ICR 764 were wrongly decided.

After M was made redundant by JE Ltd in March 2010 he brought proceedings for unfair dismissal and age discrimination. Following mediation, he reached a settlement agreement with JE Ltd under which it agreed to pay him ‘an ex gratia sum of £200,000 by way of compensation for loss of office and employment’. JE Ltd treated the first £30,000 as exempt from tax by virtue of S.403 ITEPA but deducted income tax at the basic rate from the remainder. When M completed his tax return he treated the whole sum as being tax free. HMRC disagreed and issued a closure notice. On appeal, the First-Tier Tribunal (FTT) found that the whole of the settlement sum had been paid in connection with the termination of M’s employment under S.401 ITEPA and so was chargeable to tax pursuant to S.403. M appealed against that decision to the Upper Tribunal. Among other things, he argued that the settlement sum was taken out of S.401 by S.406(b) ITEPA, which exempts from income taxation a payment or benefit made ‘on account of injury to’ an employee.

The Upper Tribunal dismissed the appeal. It agreed with the FTT that the entirety of the £200,000 settlement sum fell within S.401 as a payment made in connection with the termination of M’s employment. The section applies to payments made even where the termination was fair and lawful and includes non-pecuniary awards, such as damages for injury to feelings. Even if the sum paid might exceed the statutory maximum that could be awarded for unfair dismissal, that did not mean that the excess was unconnected with the termination of the employment.

As for the exemption in S.406, the Tribunal could not accept that, insofar as the sum represented damages for injury to feelings, it was a payment on account of ‘injury’. The meaning of ‘injury’ in S.406 ITEPA is context-specific. It could not be read as exempting all payments made by an employer in respect of an injury to an employee; rather, it was intended to apply to injuries that led to the termination of employment or to a change in duties or level of earnings. In so holding, the Tribunal stated that the EAT was wrong to decide that injury to feelings was covered by S.406 ITEPA in Vince-Cain v Orthet Ltd and Timothy James Consulting Ltd v Wilton. The obiter reasoning of the Chancery Division in Horner v Hasted (Inspector of Taxes) 1995 STC 766 was to be preferred.

Link to transcript:

Monitoring Employees’ Use of the Internet

Is the right to respect for private life and correspondence breached if employers monitor employees’ personal communications at work? No, subject to reasonableness/proportionality, according to the European Court of Human Rights in Barbulescu v Romania. Mr Barbulescu was an engineer who used his business Yahoo Messenger account to send and receive personal messages with his fiancee and his brother, including messages about his health and sex life.  This was in breach of his employment contract.  His employer, discovering this accidentally, dismissed him.  Mr Barbulescu argued that the Rumanian courts should have excluded all evidence of his personal communications on the grounds it infringed his Convention rights to privacy.

In summary:

  • any dismissal of a zero hour contract employee is automatically unfair, if the principal reason is that s/he breached a contractual clause prohibiting him/her from working for another employer
  • no qualifying period is required to bring such an unfair dismissal claim; and,
  • it is also unlawful to submit a zero hour worker (note: worker not employee) to detriments if they work for another employer in breach of a clause prohibiting them from doing so.

The Exclusivity Terms in Zero Hour Contracts (Redress) Regulations 2015

In Cooper Contracting Ltd v Lindsey, the EAT has given a useful summary of the principles that tribunals should apply when considering whether a successful claimant’s compensation should be reduced to reflect failure to mitigate loss following unfair dismissal. Mr Justice Langstaff, President of the EAT, confirmed that it is not for the claimant to prove that he or she has mitigated his or her loss, the burden of proof is on the wrongdoer, and that it must be proved that the claimant acted unreasonably.

L worked as a carpenter for CC Ltd for 21 months until it dispensed with his services in December 2013. He claimed unfair dismissal. Although CC Ltd argued that L had worked for it on a self-employed basis, the tribunal found that he was in fact an employee and went on to uphold his claim. When it came to assessing compensation, the tribunal noted that, since his dismissal, L had chosen not to seek alternative employment but had been working as a self-employed tradesman. It found that this was a reasonable course of action and that it should not limit L’s compensation for loss up to the date of the hearing on the basis of failure to mitigate. However, it noted that there were other opportunities for employed work at higher remuneration, if L wished to look for them, and considered that this justified limiting his future loss to three months. CC Ltd appealed against the compensation award to the EAT. It argued, among other things, that the tribunal’s finding that better-paid alternative employment was available to L should have led to a finding that he had failed to mitigate his loss.

The EAT dismissed the appeal. Mr Justice Langstaff, President of the EAT, rejected the suggestion that the duty to mitigate is a duty to take all reasonable steps to lessen the loss. He went on to summarise the principles governing mitigation of loss as follows: (1) the burden of proof is on the wrongdoer – a claimant does not have to prove that he or she has mitigated his or loss; (2) the burden of proof is not neutral and if no evidence on the point is put before the tribunal by the wrongdoer then the tribunal has no obligation to find it; (3) what has to be proved is that the claimant acted unreasonably; (4) there is a difference between acting reasonably and not acting unreasonably; (5) what is reasonable or unreasonable is a matter of fact; (6) it is to be determined taking into account the views and wishes of the claimant as one of the circumstances, although it is the tribunal’s assessment of reasonableness and not the claimant’s that counts; (7) the tribunal is not to apply too demanding a standard to the victim; (8) the test may be summarised by saying that it is for the wrongdoer to show that the claimant acted unreasonably in failing to mitigate; and (9) in a case in which it may be perfectly reasonable for a claimant to have taken on a better paid job that fact does not necessarily satisfy the test. It will be important evidence that may assist the tribunal to conclude that the claimant has acted unreasonably but it is not in itself sufficient.

Applying these principles to the tribunal’s judgment, Langstaff P was satisfied that there was no error of law. The tribunal had given adequate reasoning for its finding that it was reasonable for L to re-enter the job market as a self-employed tradesman; and the decision to limit future loss to three months was within the tribunal’s ‘just and equitable’ discretion in the amount of compensation to be awarded under S.123 of the Employment Rights Act 1996.