Top Tips for Termination payments following alleged discrimination

Practical points arising from Oti-Obihara and Norman v Yellow Pages 

 By way of reminder, payments made to departing employees broadly fall into three categories:

1. amounts taxable as genuine “termination payments” where, broadly, the first £30k of such amounts are not subject to income tax or NICs and any surplus above £30k is subject to income tax but not NICs;
2. amounts treated as earnings for tax purposes which, broadly, are subject to both income tax and NICs; and
3. amounts which are not taxable which can include payments made in respect of damages for injury to feelings in the context of discrimination claims. 
    

Often payments made to employees will reflect a number of different elements (some taxable and some non-taxable), and issues can arise as to how the overall sum paid should be apportioned, particularly where there have been allegations of discrimination.  We consider below certain practical points arising from two recent cases. 
 

In Oti–Obihara v HMRC, Mr Oti-Obihara claimed he had been subject to racial discrimination and harassment whilst employed by Morgan Stanley in London.  He had taken his case to the Employment Tribunal, but had eventually negotiated a settlement sum of £500,000 with Morgan Stanley whereby his employment was terminated and he waived all legal claims (both UK and US) against Morgan Stanley.  The question arose as to how much of the £500,000 was to be treated as a payment received in connection with the termination of his employment and subject to income tax (except for the first £30,000) and how much was tax free – being damages for the discrimination, including injury to feelings. 
 

The case confirmed the following:

• A compensation payment made for discrimination will be taxable if the discrimination causes the termination of employment; but only to the extent that the payment is compensation for financial loss suffered by reason of that termination.
• In apportioning the global settlement payment, the proper starting point is to identify the amount which is taxable, i.e. which can be properly characterised as being in respect of the loss of office/employment, with the balance then being non-taxable.
• The Tribunal will look to the compromise agreement (or the terms of any relevant Employment Tribunal award) in the first instance. But in the absence of any apportionment in the compromise agreement/award, the Tribunal will look to the wider context to reach an apportionment on a reasonable basis -recognising that an employer may well, in certain circumstances, compensate an employee for being unable to find comparable work for a period extending beyond the contractual notice period.
• The Vento guidelines on the appropriate level of damages for injury to feelings will not necessarily limit the amount allocated to injured feelings – a particular case may warrant aggravated damages, the appellant may also have potential claims in the US (or other jurisdictions), and such guidelines do not directly relate to negotiated payments where employers may agree to higher levels of compensation to protect reputation/retain privacy.      
   

Top tips in light of the Oti-Obihara case:

1. Where there are allegations of discrimination and a termination, it is likely to be difficult to show that the two are unrelated.  So that if there is no specific allocation of an amount to discrimination (or injury to feelings), HMRC are likely to argue that the discrimination caused the termination and that the majority (if not all) of the compensation payment is taxable (particularly where the payment does not significantly exceed the amount which might reasonably have been agreed upon in respect of financial loss).
2. Accordingly, employee’s may wish to expressly allocate a significant element of a compensation payment to discrimination (or injury to feelings) to reduce their tax liability.
3. An employer may well want to resist any express allocation, however, on the basis that:
   1. the employer does not wish to acknowledge any liability or that a substantial part of the sum paid is for injury to feelings – the essence of a compromise agreement being that neither party has to make admissions;
   2. HMRC is likely to strongly resist attempts to allocate amounts to injury to feelings (arguing that the decision in the Oti-Obihara case was peculiar to the facts and, in particular, the desire to avoid litigation in the US), particularly in a context where, in negotiating the settlement amount, an employee has previously been arguing for significant amounts in respect of financial loss;
   3. whilst the decision may make it more difficult for HMRC to dispute amounts allocated to injured feelings which exceed the Vento guidelines, it may be more prudent (particularly in a purely UK context) to keep any amounts so allocated within those guidelines;
   4. employers will be anxious to ensure that they are complying with their obligations to HMRC to pay any tax due, and to avoid a suggestion that an apportionment had been agreed to the advantage of the employee if that is not the true position;
   5. even if the parties had reached an agreement as to apportionment, HMRC would not be bound to accept it – and the employer should be careful of the risk of HMRC failing to treat amounts as non-taxable so that the employer is liable for under-deduction of tax through PAYE;
   6. as confirmed in Norman v Yellow Pages, there is no obligation on the employer to apportion a compromise payment as between the various elements and calculate the PAYE payment to HMRC accordingly; it is for the employee, and not the employer to sort out the position with HMRC.

Emma Bailey is a partner specialising in tax at Fox Williams LLP.  Emma can be contacted on ebailey@foxwilliams.com