Payment to Settle Bonus Discrimination Claim Not Taxable

A payment made to settle a potential discrimination claim for an underpaid bonus was not taxable.

In Mr A v HMRC, Mr A was a trader at a bank. He raised a grievance about the level of his 2006 and 2007 bonuses. He alleged that his employer had paid him a lower bonus than other employees because of his race. He raised a grievance and served a race discrimination questionnaire asking questions about his treatment. 

At around this time the bank was making redundancies due to a buy-out and Mr A was informed that he would be made redundant. He was paid a statutory redundancy payment and an ex gratia redundancy payment. He was also offered £600,000, without admission of liability, if he agreed to sign a settlement agreement settling all outstanding claims. He agreed.

No tax was deducted from the payment. HMRC considered that the £600,000 had been paid to make good the underpayment of bonus and sought to tax it as earnings. Mr A appealed to the first tier tax tribunal. He argued that the payment represented compensation for his threatened race discrimination claim and was not taxable. HMRC argued that as the payment had been calculated by reference to lost earnings it was taxable as “earnings are involved”.

The first tier tax tribunal agreed with Mr A. The payment could only be taxed as earnings if it was a reward for services past, present or future. The fact that the sum was calculated by reference to loss of earnings (bonus) did not make it earnings. The employer made the payment to settle a potential race discrimination claim. It was not necessary to determine whether the claim would have been successful. The payment was not taxable. 

Employers do not have to deduct tax from compensation paid to settle a potential discrimination claim, even if the compensation is calculated by reference to lost earnings. It is important to note that the payment in this case was to settle potential discrimination claims which existed before dismissal. If the employer had made the payment to settle discrimination claims arising on termination of employment, the payment would have been taxable under s401 Income Tax (Earnings and Pensions) Act 2003, under the rules relating to the taxation of termination payments. The first £30,000 of such payments is free of income tax. Income tax is payable on the balance.