Spc00734

ANONYMISED DECISION WITH THE AGREEMENT OF THE PARTIES

INCOME TAX: Compensation payable under agreement to settle a dispute of unfair dismissal before Employment Tribunal – Dispute concerned the proportion of compensation that could be regarded as employment income – Appellant argued that the majority of the compensation was for damage to reputation unconnected with the termination of his employment – satisfied that the compensation was received directly in connection with the termination except £10,000 for injury to feelings – Appeal dismissed – s 401(1) ITEPA 2003 

SPECIAL COMMISSIONERS

	“A”   	Appellant

	- and -

	HER MAJESTY’S REVENUE and CUSTOMS	Respondents

SPECIAL COMMISSIONER: MICHAEL TILDESLEY OBE

Sitting in public in London on 10 & 11 November 2008

Richard Vallat, counsel for the Appellant

John Higgins HM Inspector of Taxes assisted by David Martindale HM Inspector of Taxes for the Respondents

© CROWN COPYRIGHT 2009

DECISION
The Appeal
1.	The Appellant was appealing against an amendment to his tax return for the year ending 5 April 2004 dated 24 August 2007. The amendment resulted in an increase of £88,000 in tax due.
The Dispute
2.	On 9 October 2002 the Appellant resigned from his job as Head of Department with a Bank on being told that he would receive a written warning. On 8 January 2003 the Appellant made a claim of unfair dismissal to the Employment Tribunal seeking the remedy of compensation.  On 3 September 2003 the Appellant’s claim was settled by mediation which resulted in the Appellant receiving a payment of £250,000 from the bank together with the payment of his legal expenses. 
3.	The principal issue in dispute was how much of the settlement payment fell within section 401(1) of Income Tax (Earnings and Pensions) Act 2003 (hereinafter ITEPA 2003) as a payment in consequence of or otherwise in connection with the termination of the Appellant’s employment.  
4.	The Appellant contended that £50,000 of the £250,000 was caught by section 401(1). The balance was split between £175,000 for loss of reputation and £25,000 for injury to feelings. Thus the taxable element was £50,000 subject to the exemption of £30,000 given by section 401(1) ITEPA 2003.
5.	The Respondents contended that £240,000 of the £250,000 was caught by section 401(1).  The remaining £10,000 was attributed to injury to feelings.
6.	The Appellant’s main argument was that his reputation was irreparably damaged by sham disciplinary proceedings and the written warning that ensued. His resignation did not of itself cause the damage to his reputation, and the damage was not therefore connected with the termination of his employment. His claim before the Employment Tribunal included an element for damage to his reputation.
7.	The Respondents, on the other hand, relied on the wording of the settlement agreement which stated that the Bank would pay the Appellant £250,000 upon withdrawal of his claims before the Employment Tribunal. The claims were said to be by reason of his dismissal except a claim for injury to his feelings. Thus it was not open to the Appellant to redraft the terms of an agreement made in good faith. He was bound by his statement that the compensation claimed arose from the termination of his employment.
8.	The subsidiary dispute concerned the amount to be allocated to injury to feelings. The Appellant referred to the decision of the Court of Appeal in Vento v Chief Constable of West Yorkshire Police [2002] EWCA Civ 1871 which issued guidance to Employment Tribunals on the level of damages for injury to feelings. The Court of Appeal identified three bands of damages. The top band should normally be between £15,000 and £25,000 and reserved for the most serious cases, such as a lengthy campaign of discriminatory harassment on the ground of sex or race. The middle band of between £5,000 and £15,000 should be used for serious cases which did not merit an award in the highest band. Awards of between £500 and £5,000 are appropriate for less serious cases, such as where the complained act was an isolated or one off occurrence. 
9.	The Appellant conceded that the behaviour complained of was a single occurrence but the nature of his employer’s conduct involving sham allegations intended to intimidate him was so serious as to bring it within the top band of damages.  In the Respondents’ view, the compensation allocated to injury to feelings should be limited to a maximum of £10,000. The Respondents relied on the facts that there was no evidence of a lengthy campaign of intimidation by the employer, and that the Appellant could have continued in his job on the same terms and conditions despite the final warning.
The Legislation
10.	Section 401(1) ITEPA 2003 provides that so far as is relevant:
“This chapter applies to payments and other benefits which are received directly or indirectly in consideration or in consequence of, or otherwise in connection with –
(a)	the termination of a person’s employment”.
11.	Section 403(1) ITEPA 2003 states that
“The amount of a payment or benefit to which this Chapter applies counts as employment income of the employee or former employee for the relevant tax year  if and to the extent that it exceeds the £30,000 threshold”.
The Evidence
12.	I heard evidence from the Appellant and JB for the Appellant. JB was the Appellant’s solicitor who acted for the Appellant in respect of his claim against the Bank. JB declared that he had the Appellant’s permission to divulge information where it was necessary for the purposes of providing a coherent record of events. JB made it clear that the waiver of privilege did not go further than the matters referred to in his evidence and did not constitute a general waiver of privilege. A bundle of documents was received in evidence.
The Facts
13.	The Appellant began employment in the financial sector in London in 1986 starting as a blue button. He progressed through various positions with different banks culminating in his appointment as European Head of Department on 15 May 2000 with the Bank at its London Branch, commencing employment on 21 August 2000. His basic salary was £115,000 gross per annum. The Appellant was eligible to participate in the Bank’s discretionary bonus scheme. The Bank, however, confirmed in the Appellant’s letter of appointment that he would receive a minimum bonus award of $1,833,510 gross in respect of the 2000 performance year.
14.	The Appellant’s brief when he joined the Bank was to set up, staff and run a  department trading in European convertibles. In or about October 2000 his mandate was widened to become global which resulted in a re-designation of his job title to Global Head of Department. 
15.	The Appellant was a board member and responsible for 80 members of staff. During his tenure with the Bank his department was the most profitable part of the Bank’s activities, and ranked first in every category in the Thomson Extel Survey 2002 which compared the relative performance of banks in the convertible bond sector. 
16.	In early 2002 the Appellant became aware of practices in the Bank’s recruitment process and expressed his concerns to the Head of the Bank in London and later with his manager. The Appellant received no satisfaction from the Bank, so in March 2002 he reported the matter to the Financial Services Authority.
17.	In September 2002 the Appellant was asked to explain to the Head of the Banks Legal Department a trade that was developed by him in conjunction with the Compliance Department in July 2001.   
18.	On 3 October 2002 the Appellant was asked to attend a disciplinary hearing on 4 October 2002 to discuss alleged breaches of the Sales and General Compliance Manuals connected with the trade which was the subject of the legal department’s enquiry. As part of the disciplinary procedure the Appellant was provided with a report from the Bank’s Compliance Department which detailed the alleged breaches. The disciplinary hearing took place on 9 October 2002
19.	The Appellant initially refused to attend the disciplinary hearing because he was outraged at his treatment. As far as he was concerned the disciplinary action was a sham. The Appellant believed that the disciplinary proceedings were being taken to intimidate him because of his complaints about the Bank’s recruitment process which involved senior Bank officials.
20.	At the end of the disciplinary hearing the Appellant was informed that he would receive a Stage 3 Final Written Warning. The disciplinary decision was confirmed in writing on 10 October 2002 which stated that in issuing a warning the disciplinary panel took into account the following matters:
(1)	No procedures were followed to report an operational loss, which was disputed by the Appellant.
(2)	Failure to seek approval for an off-market trade, which was accepted by the Appellant.
(3)	Lack of record keeping with respect to verifying the actual loss – the panel accepted that the paperwork with respect to the refund of monies was not the Appellant’s responsibility.
21.	The letter dated 10 October 2002 advised the Appellant that if there was a repeat of his actions he could face dismissal. The letter would remain on the Appellant’s personnel file for 12 months, however, it might be referred to for reference purposes in line with the Financial Service Authority’s guidelines. Finally the letter advised the Appellant of his right of appeal which could be exercised within five days of receipt of the letter.
22.	 The Appellant considered that the sanction of a final written warning destroyed the trust between himself and the Bank. The Appellant concluded the he had no alternative but to resign which he did on 9 October 2002 with immediate effect. The Appellant appealed against the decision of the disciplinary panel which was heard on 4 November 2002. The Appeal panel upheld the decision to issue a final warning.
23.	The Appellant believed that the sanction would seriously damage his reputation. He was a senior City employee and subject to a strict regulatory regime. According to the Appellant, his reputation was critical to his job, it defined the risks that he could take and the amount of capital that he could invest.
24.	The Appellant acknowledged that the disciplinary proceedings and records were confidential. He believed, however, that the outcome of the hearing would leak out to bank employees and that it would compromise discussions on resources with his line manager who knew about the final warning.
25.	The Bank denied that it acted unreasonably in imposing a final written warning. The Appellant admitted that he had breached the compliance manual in that he had failed to report the trade to compliance and obtain prior approval. According to the Bank it was entitled to dismiss summarily for breaches of the compliance rules.
26.	The Appellant accepted that he could have continued in his job on the same terms and conditions despite the final warning. Under his contract he would be entitled to a bonus which was likely to exceed the £one million bonus of the previous year. The Appellant, however, believed that had he stayed the Bank officials would have found a way of not paying him the bonus.
27.	On 8 January 2003 the Appellant filed a complaint against the Bank in the Employment Tribunal for unfair dismissal claiming compensation. In addition to his claim for unfair dismissal, the Appellant claimed that certain disclosures that he made in and around early to mid-2002 were protected disclosures within the meaning of the Employment Rights Act 1996, and that as a consequence of making those protected disclosures, he was subjected to a detriment (namely the imposition upon him of a final written warning). The Appellant also claimed that his dismissal was by reason of him having made protected disclosures.
28.	Paragraph 35 of the complaint set out the remedy sought by the Appellant:
By reason of being subjected to a detriment contrary to Employment Rights Act s 47B, the Applicant seeks:
a)	A declaration to that effect, and
b)	Just and equitable compensation, namely compensation for injury to feelings.
By reason of his dismissal, the Applicant seeks compensation for his losses including:
a)	Loss of earnings, including salary and bonus – the Applicant is attempting to mitigate his loss, but has yet to find alternative employment; the Respondent has deemed the Applicant to be on garden leave until 8 January 2003, and the Applicant will give credit for the benefits received by him from his resignation until that date.
b)	Damages for distress, humiliation and damage to his reputation.
29.	The claim for dismissal on the grounds of protected disclosure removed the cap of £52,600 for damages that could be awarded by the Employment Tribunal for unfair dismissal. JB indicated that he would be asking on behalf of the Appellant for compensation of three to four million American dollars under the head of loss of earnings on the basis that it would take at least a year for the Appellant to obtain a similar position. JB, however, was doubtful that a claim of such magnitude would succeed because of the inherent caution of Employment Tribunals and the Appellant had not been assiduous with his efforts to mitigate his losses
30.	In July 2003 the Appellant and the Bank agreed to mediate. Prior to the mediation, there had been no substantive correspondence or negotiations between the parties which related to negotiation of a potential settlement of the claim. No schedule of loss was submitted by either party.
31.	The mediation took place on 3 September 2003 at which JB and the Appellant attended. The actual terms of the settlement were agreed between an official for the Bank and the Appellant in the course of a private conversation attended only by the mediator.
32.	The settlement agreement dated September 2003 included the following clauses:
(1)	The Applicant undertakes to withdraw forthwith his application to the London Employment Tribunal case number ……. on the basis that there is no order as to costs.
(2)	Within 7 days of receipt of an order from the Tribunal dismissing the Application upon withdrawal by the Applicant the Respondent (the Bank) will pay (i) the Applicant £250,000 in respect of claims made in the Application (ii) the Applicant’s solicitors £65,000 (including VAT)……
(3)	The Respondent undertakes to give a reference in the form of the attached Schedule 2 if approached by any prospective future employer of the Applicant, and to deal with any oral enquiry in a manner consistent with that reference.
33.	The reference stated that 
“We confirm that the Appellant was employed by the Bank from 21 August 2000 to 9 January 2003, in the capacity of Head of Department
We can confirm that the position was permanent, full time and established.
The Appellant was registered with the FSA as an Investment Advisor. The Appellant was registered from 21 August 2000 to the 9 October 2002. We have no reason to doubt his honesty and integrity.
The Appellant received a final written warning for breach of internal procedures in relation to a single transaction. This prompted his resignation. This was an isolated occurrence and he had not previously been subject to any investigation or disciplinary action. He made no attempt to disguise the matter. There was no question of any dishonesty on his part, or any personal interest in the transaction”.
34.	No formal notes of the negotiations conducted at the mediation were taken. The settled sum of £250,000 was not particularised. In his evidence JB proposed an apportionment of the £250,000, contending that £200,000 should be allocated to damage to reputation arising from the sham disciplinary proceedings. JB acknowledged that his apportionment of £200,000 did not withstand serious legal analysis. 
35.	On the 22 September 2003 the Bank paid the Appellant £201,600. The Bank deducted tax at basic rate in the sum of £48,400 from the taxable amount of £220,000 (the first £30,000 being free of tax). On 23 September 2003 JB on behalf of the Appellant challenged the deduction of tax. On 26 September 2003 the Bank’s solicitors responded pointing out that
“The first £30,000 is free of tax, the words in respect of the claims made in the Application were added to the draft settlement agreement to assist your client in claiming the £30,000 exemption. As regards the balance of £220,000, our client is obliged to deduct income tax at the basic rate in accordance with Regulation 24(2) of the Income Tax (Employment) Regulations 1993”.
36.	 JB confirmed that details of the Appellant’s predicament had become public knowledge amongst City traders. The Appellant was interviewed unsuccessfully for three jobs in the City after the settlement. The Appellant tried for four years to resurrect his career in the financial services industry to no avail. In the three years before joining the Bank he received four job offers within the financial industry. The Appellant has subsequently re-trained as an actor, and in a small way farming. 
Reasons for the Decision
37.	The parties accepted that the wording of section 401(1) ITEPA 2003, in particular in consequence of or otherwise in connection with termination of a person’s employment was broad. In the Respondents’ view the mere fact that compensation may be for distress or for humiliation or for damage to reputation was not sufficient to take it outside section 401(1).  If the compensation for any of the causes was made in consideration or in consequence of or in connection with the termination of employment then it was taxable as employment income. The Respondent referred to the Special Commissioners’ decision in Walker v Adams SpC344 which decided that the word otherwise in section 401(1) showed that the relevant connection between the payment and termination might be looser than would be required for a strict causation test. 
38.	The Appellant submitted that where there was a termination and a payment, it would be a matter of fact and degree whether the payment was made in connection with the termination. In the Appellant’s view there can be no such connection, however, where the termination was wholly irrelevant to the making and quantification of the payment. 
39.	The Appellant referred to the Court of Appeal decision in Revenue and Customs Commissioners v Barclays Bank PLC and another [2007] EWCA Civ 442 which considered the meaning of in connection with under section 612(1) of Income and Corporation Taxes Act 1988. The case concerned whether payments made by Barclays Bank to its pensioners and their surviving spouses as compensation for withdrawal of free assistance in preparing tax returns and executor and trustee services were made in connection with past service. The Court of Appeal observed that the expression in connection with could describe a range of links. Arden LJ concluded at paragraph 20 479:
“Thus I conclude that a connection may be indirect for the purpose of the definition of relevant benefits. Accordingly it is possible that the making of a payment will have a relevant connection with more than one thing. In that situation, it is my judgment necessary to see whether the connection can co-exist, or whether one will actually exclude the other. If, on proper analysis the further connection displaces a prior connection, the prior connection ceases to be a relevant connection for the purpose of section 612(1)”.
40.	The Appellant submitted that the evidence in this case demonstrated that a substantial part of the compensation paid to the Appellant was for damage to his reputation which was caused by the issue of a final warning emanating from the sham disciplinary proceedings.  Thus the relevant connection in this case had nothing to do with the Appellant’s termination of employment.
41.	The Appellant’s proposition was based on his evidence that he worked in a unique position where reputation was crucial to his continued success. The very fact that he was subject to a disciplinary procedure which resulted in a final warning caused irreparable damage to his reputation and made his continuing employment with the Bank untenable. The sham nature of the disciplinary procedure was demonstrated by the severity of the penalty for a technical breach of the reporting requirements for off-market trades, the size of the compensation award which was five times the capped damages that could be awarded by the Employment Tribunal and the wording of the reference. JB confirmed in evidence that news of the Appellant’s predicament had leaked out to fellow traders. The Appellant had been unable to resurrect his career in the financial sector. Given this background JB postulated that £200,000 of the compensation could be attributed to the Appellant’s claim for loss of reputation which was unconnected with whistle blowing. JB thought it unlikely that an Employment Tribunal would have awarded the Appellant compensation for loss of earnings in excess of the £52,600 cap. JB pointed out that whistle blowing was by its nature an extremely difficult claim to prove, and the Appellant had a problem with mitigation. JB believed that the Bank would have had these considerations in mind when agreeing to a compensation award of £250,000.
42.	I was not convinced with the evidential basis for the Appellant’s proposition. I found the evidence relied upon short on fact consisting of unsubstantiated inferences and conjecture. The sham nature of the disciplinary proceedings was not apparent from the documents produced. On the face of it the Bank’s procedures were transparent consisting of a hearing with a right of appeal supported by documentation setting out the allegation, the procedures, and a reasoned decision. The Appellant’s allegation of a sham was not independently verified. The Appellant accepted that the Bank’s disciplinary procedures were confidential. The Appellant adduced no evidence that the Bank was responsible for the leaks about his predicament.
43.	The circumstantial evidence of the size of compensation award and the wording of the reference did not justify the inferences drawn by the Appellant. The size of the compensation was modest when compared with the loss of earnings at stake amounting to £1.4 million, and the Appellant’s initial claim for loss of earnings which according to JB would have been about $3 to $4 million. The wording of the reference was factual, and replicated the outcome of the disciplinary hearing. According to the Bank the sanction of a final warning was not disproportionate for breach of compliance rules which had been admitted by the Appellant.
44.	JB’s proposed apportionment of £250,000 was conjecture on his part. He accepted that there no record of how the figure of £250,000 was arrived at during the mediation process. I formed the impression from JB’s evidence that only global figures were discussed at the mediation. Mr Ferguson conceded in his witness statement that his purported apportionment of £200,000 for loss of reputation did not survive serious legal analysis.  JB acknowledged in his evidence that his purported apportionment of the £250,000 was in response to the Respondents’ request to provide an apportionment, with the implication that apportionment did not form part of the actual negotiations with the Bank.
45.	The Appellant’s principal weakness in his case was his failure to undermine the compelling evidence of the settlement agreement, which demonstrated a direct link between the compensation and the termination of the Appellant’s employment. The settlement was agreed to by the Appellant having been advised by his solicitor. Under the terms of the agreement the compensation of £250,000 was payable on withdrawal of his claims before the Employment Tribunal. Those claims except that for injury to feelings were directly related to his dismissal.
46.	The Appellant in his claim before the Employment Tribunal clearly stated that the damage to his reputation flowed from his dismissal. This in my view was a more plausible explanation for reputational damage than the one proffered by the Appellant which was based on the sham nature of the disciplinary proceedings. As stated above there was no persuasive evidence of the sham nature of the proceedings. Moreover the Appellant conceded that he could have continued in his job on the same terms and conditions despite the final warning.  
47.	The Bank’s letter of 26 September 2003 responding to JB’s query about deduction of tax disclosed the parties’ intentions with respect to the settlement agreement. The Bank’s insistence that the compensation was subject to deduction for income tax, demonstrated that the Bank viewed the compensation as employment income. Interestingly the letter revealed that the words in respect of the claims made in the Application were added to the draft settlement agreement to assist the Appellant in claiming the £30,000 exemption. In my view the revelation showed that the Appellant linked the compensation with his termination.
48.	I find that the Appellant’s termination of his employment gave rise to his claims for compensation before the Employment Tribunal. The claims except for injury to feelings were made by reason of his dismissal from employment. The payment of compensation was made to discharge those claims. I, therefore, hold that the compensation paid except that for injury to feelings was directly connected to the termination of his employment.  
49.	I find that the facts of this case did not bring them within the most serious category of damages for injury to feelings as set out in the Court of Appeal decision in  Vento v Chief Constable of West Yorkshire Police. The Appellant conceded that there was no evidence of the Bank conducting a lengthy campaign of harassment against him which was the defining characteristic of the most serious category. The Appellant considered that an award in the most serious category was justified because he was intimidated by the sham disciplinary proceedings. Also JB believed that the Appellant stood a very good chance of receiving an award in the most serious category, particularly taking into account the overall size of the claim. The circumstances relied upon the Appellant lacked objectivity. The Appellant was entitled to return to his job on the same terms and conditions. The bank’s conduct constituted an investigation which followed transparent procedures into a complaint that the Appellant had not met compliance regulations. The investigation did not go beyond the terms of the complaint. In those circumstances I prefer the Respondents’ position which was that the compensation allocated to injury to feelings should be limited to a maximum of £10,000.
Decision
50.	I decide the following in respect of the apportionment of the £250,000 compensation paid to the Appellant under the agreement dated 3 September 2003
(1)	£240,000 was directly connected to the termination of his employment, and, therefore, counts as employment income subject to the £30,000 exemption.
(2)	£10,000 allocated for injury to feelings, which does not count as employment income.
51.	The Appeal is dismissed.

                                

                                    MICHAEL TILDESLEY OBE
SPECIAL COMMISSIONER
RELEASE DATE: 4 February 2009

SC