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Taxation of Compensation Payments for Injury to Feelings - What is the Current Position?

on Friday, 27 April 2018.

In the recent case of Moorthy v HMRC, the Court of Appeal held that a payment to the Claimant for injury to feelings was not taxable under the Income Tax (Earnings and Pension) Act 2003 (ITEPA).

The Case

The Claimant, Mr Moorthy, and his employer agreed a £200,000 settlement package in relation to Mr Moorthy's claim for unfair dismissal and unlawful age discrimination. The parties agreed that £30,000 of the settlement was attributable to compensation for injury to feelings in respect of the alleged age discrimination.

Under ITEPA, payments made in connection with the termination of a person's employment are taxable, to the extent which they exceed the £30,000 tax exemption threshold. However, section 406 of ITEPA provides that compensation paid "on account of injury to…an employee" is exempt from income tax.

HMRC argued that injury to feeling fell outside of the 'injury' exception. However, the Court of Appeal disagreed and held that awards for injury to feelings do fall within the 'injury' exception and therefore there was no tax to pay.

Impact of the Changes Brought in by the Finance Act 2017

Whilst this case provided certainty on previously unclear case law, it is of limited importance. From 6 April 2018 section 406 of ITEPA has been amended to specify:

"Although injury… includes psychiatric injury, it does not include injury to feelings."

This provides conclusively that a payment for injury to feelings in respect of discrimination connected with termination now falls outside of the tax free exemption for personal injury (except where the injury amounts to a psychiatric injury) and will therefore be taxable.

Best Practice

It is worth noting that a payment for injury to feelings in relation to discrimination which is not related to the termination of employment can still be paid tax free. It is therefore important to ensure that any settlement agreement entered into clearly specifies what a payment represents.

In this case, the Court held that the fact that the agreement described itself as representing "compensation for loss of office and employment" made it clear beyond reasonable doubt that the £200,000 payment was in connection with the termination of employment and therefore was within the taxable regime.


For more information please contact Charlotte Rose in our Employment Law team on 0117 314 5219, or complete the below form.

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