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Police get fair tax treatment on compensation

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An out of court settlement paid to police officers for unpaid overtime and hardship allowances should not have been taxed as if it entirely consisted of employment income.

6th Aug 2021
Tax writer
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The Upper Tribunal (UT) has been called upon to settle yet another case regarding the taxability of compensation settlements.

The truth

Keith Murphy UT/2020/0093 was a test case for a number of police officers who sued the Metropolitan Police Service (the Met) for unpaid overtime and hardship allowances. Rather than take the matter to court, the Met entered into a damages-based agreement (DBA) with the officers, resulting in a pay-out of £4.2m plus costs.

HMRC chose to subject the entirety of the settlement to income tax and NIC, based on the premise that the underlying source of the payment was employment income. If that income had been paid on time and without litigation it would have been subject to both PAYE and NIC.

Murphy appealed.

The whole truth

The agreement was that the Met would pay, in full and final settlement of all claims:

  • A “principal settlement sum” of £4.2m, plus
  • Agreed costs, defined as “the legal costs and disbursements plus VAT of the claimants’ solicitors and counsel as assessed by the court or as agreed with the Met”.

The principal settlement sum and agreed costs together made up the “global settlement sum”. 

The manner in which the Met’s payment was made was settled in the DBA as follows:

  • The solicitors (SMB) and counsel were due a success fee of 30% of sums recovered, capped at £1.2m. This would be paid by the Met as the very first step, upon receipt of an invoice from SMB addressed to the claimants but stated to be payable by the Met.
  • An insurance firm had charged a £50,000 premium to insure the claimants against the risk of having to meet any of the Met’s costs in the event of an unsuccessful claim. The Met would settle this charge out of the balance of the global settlement sum.
  • The residue of the global settlement sum was to be apportioned between the claimants in accordance with a spreadsheet prepared by SMB. Payments would be subject to withholding of income tax and NIC.

Nothing but the truth?

The first-tier tribunal (FTT) ruled in favour of HMRC. The FTT’s judgment hinged on the question: “whether the payment of the success fee and the insurance premium arose from Murphy’s employment or from something else”.

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Replies (3)

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Scooby
By gainsborough
06th Aug 2021 13:03

I fought the law and the law won....

Thanks (1)
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By Hugo Fair
09th Aug 2021 17:06

So just to be clear, despite the sub-heading of "An out of court settlement paid to police officers for unpaid overtime and hardship allowances should not have been taxed as if it entirely consisted of employment income" ...

The finding was NOT that "unpaid overtime and hardship allowances should not have been taxed as .. employment income" - which would have been a very strange conclusion.
It is merely that the settlement included amounts unrelated to employment income (in this case specifically related to the costs of the success fee and the insurance premium, which the claimants had to incur in order to pursue the claim and obtain the settlement).

So nothing really surprising - other than HMRC yet again wasting our money chasing a 'case' that had neither legal nor moral merit.

Thanks (1)
Replying to Hugo Fair:
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By Andy Keates
13th Aug 2021 15:08

Hugo,
You appear to have ignored the word "entirely" in the subhead. Indeed, you then go on to criticise a misquotation which deliberately omits that word. Straw man, much?

The concept of entirety was the key issue in the case - HMRC treated the payment as monolithic, and the Tribunal rightly found that there were elements which had a different character than that of employment income and should therefore not be taxed as such.

Thanks (0)