Payment for a restrictive undertaking: s 225 or s 401?
The taxation treatment of amounts received by an employee on leaving employment can be fraught, and is notoriously fact-specific. Nonetheless, there are some ground rules, as the recent anonymised case of Mrs A v HMRC [2022] UKFTT 421 (TC) reminds us. And it also reminds us that appealing to the tribunal carries the risk that your tax bill may be increased, not reduced.
Mrs A had held a senior position in a retail organisation. She alleged that in the course of her employment she had been harassed, bullied, victimised and intimidated by the owner of the organisation. She settled out of court for a payment of £1.1m.
£45,000 was in compensation for ‘injury to feelings and aggravated damages’ arising from her treatment during her time as an employee. There was no dispute about the tax treatment of that amount: it wasn’t taxable.
The balance was expressed as being ‘compensation for the termination of your employment and any and all claims you have or may have against the Employer, [the Owner]’ etc.
There are two possible heads of charge on such amounts. First stop is s 225, which charges tax on a payment made in respect of ‘an undertaking which restricts [an] individual’s conduct or activities’ given ‘in connection with the individual’s current, future or past employment’.
Most settlement agreements on the termination of employment include an undertaking on the part of the employee to discontinue legal proceedings. In principle, payment for such an undertaking falls within s 225. But it is HMRC’s published practice to accept that no chargeable value is to be attributed to a limited undertaking of that kind.
However, settlement agreements usually include much wider undertakings. Mrs A’s was not untypical: she agreed among many other things to keep confidential all details of the grievance, the termination of her employment, the Employment Tribunal proceedings and the settlement agreement; and not to make any derogatory or detrimental statements about her employment, the employer or the owner. Payment for such wider undertakings falls within s 225.
It was contended on behalf of Mrs A that s 225 should be read as applying only to undertakings that restrict conduct or activities in connection with the individual’s current, future or past employment. The First-tier Tribunal (FTT) disagreed: if the undertakings were given in connection with an employment (as Mrs A’s plainly were), then it didn’t matter whether they affected Mrs A’s employment or her personal life – they fell within s 225.
That disposed of the appeal. But the FTT went on to consider whether, if it was wrong as regards the application of s 225, the amount was nonetheless chargeable to tax under s 401, which charges to tax any ‘payment received in connection with the termination of an employment’ or whether, as Mrs A contended, it had no connection with the termination but was wholly in consideration of her entering into the confidentiality and non-disclosure obligations.
Again, the FTT found against Mrs A. The ‘additional purpose or effect’ of the agreement in securing confidentiality and non-disclosure did not mean that there was no connection with the termination. Having regard to the terms of the agreement and all the evidence in the round, there was such a connection.
It’s worth noting that HMRC’s position had been that the charge lay under s 401, which affords exemption for the first £30,000 of the amount. The FTT found that the charge lay under s 225 (which affords no similar exemption). So this is another of those cases where the effect of the FTT’s decision has been to increase the taxpayer’s liability beyond the figure that HMRC had been seeking.
Home >Articles > Mrs A’s appeal: tax and settlement agreements
Mrs A’s appeal: tax and settlement agreements
Payment for a restrictive undertaking: s 225 or s 401?
The taxation treatment of amounts received by an employee on leaving employment can be fraught, and is notoriously fact-specific. Nonetheless, there are some ground rules, as the recent anonymised case of Mrs A v HMRC [2022] UKFTT 421 (TC) reminds us. And it also reminds us that appealing to the tribunal carries the risk that your tax bill may be increased, not reduced.
Mrs A had held a senior position in a retail organisation. She alleged that in the course of her employment she had been harassed, bullied, victimised and intimidated by the owner of the organisation. She settled out of court for a payment of £1.1m.
£45,000 was in compensation for ‘injury to feelings and aggravated damages’ arising from her treatment during her time as an employee. There was no dispute about the tax treatment of that amount: it wasn’t taxable.
The balance was expressed as being ‘compensation for the termination of your employment and any and all claims you have or may have against the Employer, [the Owner]’ etc.
There are two possible heads of charge on such amounts. First stop is s 225, which charges tax on a payment made in respect of ‘an undertaking which restricts [an] individual’s conduct or activities’ given ‘in connection with the individual’s current, future or past employment’.
Most settlement agreements on the termination of employment include an undertaking on the part of the employee to discontinue legal proceedings. In principle, payment for such an undertaking falls within s 225. But it is HMRC’s published practice to accept that no chargeable value is to be attributed to a limited undertaking of that kind.
However, settlement agreements usually include much wider undertakings. Mrs A’s was not untypical: she agreed among many other things to keep confidential all details of the grievance, the termination of her employment, the Employment Tribunal proceedings and the settlement agreement; and not to make any derogatory or detrimental statements about her employment, the employer or the owner. Payment for such wider undertakings falls within s 225.
It was contended on behalf of Mrs A that s 225 should be read as applying only to undertakings that restrict conduct or activities in connection with the individual’s current, future or past employment. The First-tier Tribunal (FTT) disagreed: if the undertakings were given in connection with an employment (as Mrs A’s plainly were), then it didn’t matter whether they affected Mrs A’s employment or her personal life – they fell within s 225.
That disposed of the appeal. But the FTT went on to consider whether, if it was wrong as regards the application of s 225, the amount was nonetheless chargeable to tax under s 401, which charges to tax any ‘payment received in connection with the termination of an employment’ or whether, as Mrs A contended, it had no connection with the termination but was wholly in consideration of her entering into the confidentiality and non-disclosure obligations.
Again, the FTT found against Mrs A. The ‘additional purpose or effect’ of the agreement in securing confidentiality and non-disclosure did not mean that there was no connection with the termination. Having regard to the terms of the agreement and all the evidence in the round, there was such a connection.
It’s worth noting that HMRC’s position had been that the charge lay under s 401, which affords exemption for the first £30,000 of the amount. The FTT found that the charge lay under s 225 (which affords no similar exemption). So this is another of those cases where the effect of the FTT’s decision has been to increase the taxpayer’s liability beyond the figure that HMRC had been seeking.
