When can compensation for discrimination be paid tax free?

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Summary: A recent decision of the First-tier Tax Tribunal considers whether compensation under a settlement agreement for discrimination during the course of employment can be paid tax free.

There have been a number of cases on the tax status of payments made under settlement agreements. We look at the most recent case on compensation for discrimination which occurs during employment. We also consider the wider framework that applies if you are negotiating a settlement with an employee.

Mr A v HMRC – compensation for discrimination during employment is not taxable

The employee alleged that he had been subjected to discrimination in the form of poor bonuses and pay increases. He was later made redundant and entered into a settlement agreement under which he received £600,000 in settlement of any claims. This payment was in addition to his statutory and enhanced redundancy payments.

The tax tribunal accepted that the compensation payment was made to settle the potential discrimination claim and did not constitute taxable earnings. This was despite the fact that it was calculated by reference to his salary and that there was no admission of discrimination and no specific sum attributed to the settlement of discrimination claims in the settlement agreement.

This is a helpful decision for employers. However, a further key factor was that the alleged discrimination occurred long before the redundancy situation. This meant that it did not fall within the tax regime which applies to termination payments, whether paid to settle discrimination or otherwise.

The wider framework: how to tax a settlement payment

Read our table which summarises the tax treatment of various types of settlement payment.

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