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Injury to feelings awards are exempt from tax – new EAT decision 5 March 2015
I have previously blogged on the question of whether awards for injury to feelings are taxable in the context of settlement agreements: (see link)
The EAT (presided over by Singh J) in Timothy James Consulting Ltd v Wilton concluded that awards for injury to feelings are exempt from tax. In doing so, it declined to follow the First Tier Tax Tribunal decision in Moorthy v HMRC which held there is no exemption from tax for awards for injury to feelings.
The facts of Timothy James Consulting are unremarkable and will not be rehearsed here. The Employment Tribunal had grossed up the award for injury to feelings as it thought it was subject to tax. Was it right to do so?
The EAT was tasked with interpreting section 406 ITEPA which contains an exemption from tax if the payment in question was provided “on account of injury to, or disability of, any employee”. The section also contains a side note which reads: “Exception for death or disability payments and benefits”.
First, the EAT interpreted the word “injury” to cover, on the face of it, “any injury”. Second, it considered that the side note was of limited assistance in interpreting the scope of the provision. Third, was the term confined to physical injury of a kind that could be subject to a claim in negligence or did it extend to include injury to feelings in a discrimination context? Singh J was persuaded by HHJ McMullen QC’s analysis in Orthet v Vince Cain  ICR 374 (which the FTT in Moorthy had criticised as misreading the relevant provision of ITEPA). The EAT therefore concluded that “injury” includes awards for injury to feelings and declined to follow Moorthy.
So what is the position now for practitioners advising on settlements in discrimination cases given the conflicting authorities between the EAT and the tax tribunal? First, it should be noted that the EAT decision is not binding on tax tribunals as the latter enjoy jurisdiction in interpretation of tax statutes. Second, until the Court of Appeal addresses the conflict, the most sensible option is to ensure appropriate indemnities are included in settlement agreements. HMRC is most likely to follow the tax tribunal decision in Moorthy for obvious reasons. Employment lawyers may rely on the EAT decision before the ET as it is binding on the ET, but clients should be warned that HMRC may still pursue them, particularly where the award is very high. Finally, the observations in Moorthy that there is no special tax relief for payments made to protect an employer’s reputation or privacy should still be heeded.
Should the matter be addressed by the Court of Appeal, my own personal view is that the EAT in this case reached the correct statutory interpretation. Although the taxing net is cast widely under s.401, equally the exemption in section 406 should be construed widely as the term “injury” is not qualified by words such as “physical” or “mental”. If Parliament intended to exclude awards for injury to feelings from s.406, it could have done so when enacting ITEPA 2003, as previous legislation contained similar wording in the 1988 Act. Further, discrimination awards have been with us a long time and Parliament has had ample opportunity to amend section 406 if it wished to expressly exclude awards for injury to feelings from tax relief.
On a separate but related issue, also involving a conflict of authorities, the EAT most recently in Chawla v Hewlett Packard, has held that the 10% uplift which should be applied to awards for general damages (following Simmonds v Castle  1 WLR 1239), does not apply to awards for injury to feelings. There are now two EAT cases which have ruled that the 10% uplift does not apply (De Souza v Vinci Construction UK Limited) and two which have said it should apply: The Cadogan Hotel Partners Ltd v Ozog and The Sash Window Workshop Ltd v King). It is understood that the Court of Appeal will address the issue in the De Souza case later this year.