EIM12966 | Termination payments and benefits: previous version of EIM12965: statutory compensation for discrimination and compensation for hurt feelings

The following text was previously included in the Employment Income Manual at EIM12965.

The guidance at EIM12965 has now been updated to clarify that compensation payments may be taxable under provisions other than s401 ITEPA 2003 in certain circumstances.

The wording of the previous guidance (copied below for reference) does not accurately reflect HMRC’s view of the legislation in that it states that compensation payments for discrimination can only be taxable under s401 ITEPA 2003. It should not be relied upon for payments made after 5 April 2021.

Apart from the Employment Rights Act 1996 (see EIM12950) there are many statutory provisions that provide rights to compensation for various forms of discrimination by employers.

The most common claims are in respect of discrimination on grounds of sex, disability, politics and religion. Compensation for such discrimination may be paid under several different heads, such as for loss of earnings, personal injury, injury to feelings and so on. Each head needs to be considered separately.

Such payments are taxable only under Section 401 ITEPA 2003. Further, they are only taxable where they are “connected” (see EIM13012) with the termination (or, less commonly, with a change in duties or earnings) of the employment. If the settlement does not specify what part of the payment is so “connected”, the facts must be analysed with care and part apportioned, if necessary, on a just and reasonable basis.

Any part of the settlement that can reasonably be attributed to discrimination occurring before the termination should be accepted as not being employment income as it is not “connected” with the termination. However, where the compensation relates only to the consequences of the termination itself, no apportionment will be appropriate. For example, if the compensation is for loss of future earnings (after termination) it is all connected with the termination and Section 401 ITEPA 2003 applies even though the discrimination brought about the termination. If, by contrast, the compensation is for injury to feelings and there was discrimination before termination, then any part of that compensation that is not connected with the termination will not be within Section 401 ITEPA 2003.

The Special Commissioners’ Decision in Walker v Adams (SpC344) may be cited in this context. It confirmed that Section 401 applies to statutory discrimination compensation, in this case for loss of earnings resulting from termination after religious discrimination. The statement that a payment made as compensation for hurt feelings was not taxable was based on the Commissioners’ view that all discrimination took place pre-termination, and was accepted by HMRC on that basis only.

An example of compensation for discrimination that falls wholly within Section 401 ITEPA 2003 is that paid as compensation for sexual discrimination to members of the armed forces who were once dismissed on becoming pregnant. In that case, the whole payment is “connected” only to the discrimination suffered in respect of the termination itself and not to any earlier act or event.

An example of compensation for discrimination that falls only partly within Section 401 ITEPA 2003 is that paid as compensation for sexual discrimination occurring over a period leading up to termination and also inherent in the termination itself. To establish the part within Section 401 ITEPA 2003, the facts need to be examined and a reasonable apportionment agreed.

(This content has been withheld because of exemptions in the Freedom of Information Act 2000)