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Sum paid under settlement agreement could not be apportioned for tax treatment

on Friday, 08 March 2024.

The Upper Tribunal has found that an entire settlement sum was used as a termination payment for tax legislation purposes, even though it was also used to settle claims for pre-termination discrimination.

Tax treatment of termination payments

Termination payments that fall under the relevant provision of the Income Tax (Earnings and Pension) Act 2003 (ITEPA) are taxable, subject to the relevant thresholds (including that the first £30,000 of such a payment can be made tax-free).

ITEPA provides that any payment or benefit received "directly or indirectly in consideration or in consequence of, or otherwise in connection with the termination of a person's employment" will be caught. On the other hand, payments for discrimination not related to the termination of employment and can therefore be paid free of income tax.


In the case of Mathur v HMRC, the claimant brought Tribunal proceedings against her former employer following the termination of her employment. The claims included:

  • Unfair dismissal
  • Whistleblowing detriment
  • Sexual harassment
  • Equal pay
  • Victimisation

Some of the claims related to the claimant's alleged treatment prior to the termination of her employment. Other claims related to the actual termination of her employment.

The dispute was ultimately settled under a settlement agreement. The settlement sum paid under the agreement was £6,000,000. The agreement stipulated that this settlement sum would be expressly paid subject to any reductions for tax as may be required, having set aside the £30,000 tax free element.

The claimant's former employer deducted almost £3,000,000 from the settlement sum under PAYE, having determined that it was not prepared to accept any risk in relation to the tax position under the settlement agreement. The claimant sought to argue that the settlement sum should be apportioned so that the amount attributable to her pre-termination claims should be excluded from the scope of ITEPA and therefore be paid tax-free.   

The First Tier Tribunal found that the entire settlement sum fell within the scope of the ITEPA provisions and was therefore taxable. The claimant appealed to the Upper Tribunal.

Decision of the Upper Tribunal

The Upper Tribunal agreed with the First Tier Tribunal, finding that the entire settlement sum fell within the scope of ITEPA and was therefore taxable as employment income. It further found that it was not possible to apportion part of the settlement sum in order to account for the pre-termination claims.

The requisite connection between the settlement sum and the termination of the claimant's employment was established because the termination was central to significant claims made by the claimant in the Tribunal proceedings. The claims allowed her to establish her negotiating position. It was not possible to apportion the disputed sum, because the settlement sum was undifferentiated in the settlement agreement - which simply described the entire payment as 'damages'. There was also a lack of evidence to support the claimant's argument that the payment should be apportioned.

Learning points

Employers negotiating settlement agreements may typically resist apportioning settlement sums, given the general desire to make payments to achieve a clean break, without admission of liability. However, it is possible that as a result of this decision, employee representatives may seek to negotiate on this point, particularly for high value settlement sums.

For more information or advice, please contact Gareth Edwards in our Employment team on 0117 314 5220, or complete the form below.

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