NDA taints tax treatment of compensation payment

In Mrs A v HMRC [2022] TC8640, the First Tier Tribunal (FTT) held that a compensation payment made to an employee who agreed not to pursue her grievances at the Employment Tribunal was fully taxable as a payment for a restrictive undertaking. The £30,000 termination payment exemption did not apply.

Mrs A who was bringing a case in the Employment Tribunal for various grievances, including sexual harassment, signed a settlement agreement with her employer:

• In return for withdrawing an employment tribunal claim and any other claims she may have against her employer, she received a compensation payment of £1,055,000.
• She agreed to be bound by certain confidentiality and non-disclosure obligations.
• The employer treated the sum as a termination payment and deducted tax under PAYE. This was all in accordance with the settlement agreement signed by Mrs A.
• Mrs A wrote to HMRC to request a refund. In her tax return for the year, she claimed an overpayment of £467,684.
• HMRC opened an enquiry. This resulted in them issuing a closure notice for £461,588 on the basis that the compensation was taxable as a Termination payment under s.401 and therefore s.403 ITEPA 2003 meaning that only £30,000 was non-taxable. Their alternative argument at the FTT was that it was a payment for a Restrictive undertaking taxable as earnings under s.225 ITEPA. This takes priority over s.403 and is taxable in full i.e. there is no £30,000 exemption.
• Mrs A Appealed contending that the payment had no connection to the termination of her employment and was wholly in consideration of her agreement to enter into the confidentiality and non-disclosure obligations.

The FTT dismissed the appeal:

• Any undertaking which restricts the individual’s conduct or activities and is given in connection with their employment is within the scope of s.225.
• There is no doubt that an agreement not to pursue claims or proceedings is a restrictive undertaking within the scope of s.225
• The compensation payment was not damages, it was paid in respect of the restrictive undertaking given by Mrs A that she would not make or pursue any claims against her employer relating to or arising out her employment or its termination. It was therefore taxable as earnings under s.225.
• Had s.225 not applied, the payment would have been a termination payment taxable under s.403 and there was no scope for apportioning part of it as consideration for the confidentiality and non-disclosure obligations.

Useful guides on this topic

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Golden handshakes, signing on fees and unusual payments
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Unfair Dismissal
What is unfair dismissal? What are the rights of the employee and employer? What issues must the employer consider in dismissing a member of staff?

Wrongful Dismissal
When can an employee make a claim for wrongful dismissal?

External link

Mrs A v HMRC [2022] TC8640