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Court of Appeal Rules on Injury to Feelings Compensation

Those who suffer unlawful discrimination in the workplace are entitled to be compensated for injury to their feelings, and such payments are usually tax free. The Court of Appeal recently considered whether this applied where the payment is part of a termination settlement.

The case concerned a company director, aged in his mid-50s, who claimed that he had been selected for redundancy due to his age. After he complained of unfair dismissal and age discrimination, the company agreed to pay him £200,000 on an ex-gratia basis.

The settlement was agreed without admission of liability and, at the time, the sum was not apportioned between the constituent parts of his claims. After an issue arose as to whether the payment was taxable, the First-tier Tribunal found that it was subject to Income Tax. The Upper Tribunal (UT) subsequently upheld that decision.

In ruling on the man’s appeal against the UT’s ruling, the Court agreed that the sum was in principle taxable by operation of the Income Tax (Earnings and Pensions) Act 2003. It was clear that the sum had been paid to him directly or indirectly in consideration or in consequence of, or otherwise in connection with, the termination of his employment.

However, the Court found that the amount relating to the man’s injury to feelings – which the parties agreed at £30,000 – fell within the tax exemption provided by Section 406 of the Act, which extends to compensation payments for injuries suffered at work. The UT had erred in law in finding that it only applied to physical injuries.

The Court noted that awards of compensation for injury to feelings had been expressly authorised by Parliament as a means of combating various forms of unlawful discrimination. The fact that the man’s injury was to his feelings alone did not make it any less an injury and, on a natural reading of Section 406, it fell within the exemption. However, the Court also observed that such a case is unlikely to arise again: the law has now been clarified to specifically exclude payments for injury to feelings from the exemption under Section 406. Payments made on termination of employment that relate to psychiatric injuries remain tax exempt, however.

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