Controversially in some quarters, settlements of employment disputes are commonly subject to strict non-disclosure agreements (NDAs). In an important ruling, the First-tier Tribunal (FTT) has given comprehensive guidance on the tax consequences of such agreements (Mrs A v The Commissioners for Her Majesty's Revenue and Customs).
The case concerned a woman who claimed to have suffered sexual harassment at work. Her allegations were firmly denied by her former employer and its owner. Subject to an NDA, a settlement was ultimately agreed whereby she received a compensation sum of £1,055,000.
As part of the settlement, she agreed to withdraw an Employment Tribunal (ET) complaint against the defendants and waived any further claims that she may have had against them. By the NDA, she agreed to be bound by confidentiality and non-disclosure obligations in relation to, amongst other things, the ET claim, the alleged events that gave rise to it and the terms of the settlement.
HM Revenue and Customs (HMRC) took the view that the compensation sum was subject to Income Tax and rejected her claim for a refund of overpaid tax in the sum of £461,547. Challenging that decision, she asserted that the compensation sum was unconnected to the termination of her employment and was paid wholly in consideration of her agreeing to enter into the NDA.
Dismissing her appeal, however, the FTT agreed with HMRC that her agreement not to make or pursue any further claim against the defendants was a restrictive undertaking entered into in connection with her past employment. Under Section 225 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA), the compensation sum was therefore taxable in the year she received it.
The FTT ruled that all but £30,000 of the compensation sum was also taxable under Section 401 of the ITEPA in that the payment was connected to the termination of her employment. Although the sum was, in part, consideration for her entering into the NDA, it was not practicable to apportion the payment between elements relating to the termination of her employment and other elements.
For expert advice on Settlement Agreements and NDAs, contact Emma-Louise Hewitt e.hewitt@sydneymitchell.co.uk on 08081668860
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