A tax on both fronts

Recent Tax Appeal Commission decisions bear thinking about when settling an employment dispute concerning a termination payment on retirement or removal from office.

Tax Appeal Commission decisions 12TACD2020 and 13TACD2020 considered how termination payments on retirement or removal from office are treated for tax purposes and how, if an employment dispute concerning such payments is settled or mediated successfully, such payments are to be considered in a written settlement agreement.

While this article does not propose dealing with all of the varied and complex legislation concerning taxable income, I will address certain relevant provisions arising from both of these cases. Unless otherwise specified, all references to legislation relate to the Taxes Consolidation Act 1997.

Section 123 provides for the general tax treatment of payments made on retirement or removal from office. Payments received on the termination of an employment are taxable; however, section 192A(6) provides that payments to which that section applies shall be exempt from income tax. 

Exemptions

Section 192A exempts certain payments made under a ‘relevant act’ to an employee or former employee by their employer, made in accordance with a recommendation, decision or determination by a ‘relevant authority’.

A ‘relevant act’ is defined as meaning “an enactment which contains provisions of the protection of employees’ rights and entitlements for the obligations of employers towards their employees”. Examples of such acts include the Redundancy Payments Acts 1967-2014 and the Unfair Dismissals Acts 1977-2015.

A ‘relevant authority’ includes the Workplace Relations Commission, the Labour Court and/or the High Court.

Section 192A(3) applies to a payment made in accordance with a settlement arrived at under a mediation process provided for in a relevant act.

Section 192A(4) provides an exemption for a payment made in settlement of a claim provided certain conditions are met:

• The agreement must be evidenced in writing,
• The agreement must not be between connected parties (for example, an employer and a relative, an employer and a director),
• Had the claim been made to a relevant authority, it would have been a bona fide claim under a relevant act (for example, a stateable claim, in the correct forum, made within time),
• Had the claim not settled by agreement, it must have been one that was likely to have been the subject of a recommendation, decision or determination under that act by a relevant authority that a payment be made to the person making the claim,
• The amount of the payment must not exceed the maximum payment allowed by the relevant act, had the claim not been settled by agreement.

The section also provides that copies of the agreement and the statements of claim shall be made available to the Revenue Commissioners on request.

Section 192A(5) provides that the exemptions will not apply in relation to payments in respect of remuneration, however described, including arrears of remuneration or to any payments falling within section 123.

Amended assessment

Case 13TACD2020 concerned an appeal to a Notice of Amended Assessment to Income Tax for the year 2012, which the taxpayer appealed. The appellant taxpayer was an employee who had issued High Court proceedings against the employer in 2012.

A settlement agreement was subsequently entered into between the taxpayer, the employer, and a third company in 2014, prior to the hearing of the High Court proceedings. The agreement recited the terms upon which the parties agreed to settle matters arising from the proceedings, the taxpayer’s employment and the termination of the employment.

Of particular note was the clause concerning ‘payments and arrangements’, which provided for, among other things, a payment of €95,000 for ‘special damages’, which was broken down between loss of earnings, medical expenses, miscellaneous expenses, and future losses. It was the charge to tax of this payment that was appealed.

It was submitted, on behalf of the taxpayer, that the payment described as ‘special damages of €95,000’ was not payment in respect of remuneration, but represented a payment coming within section 192A(4) and, consequently, the exemption in section 192A(6) applied.

The taxpayer submitted that the payment was an out-of-court compensation payment quantified by reference to salary, rather than a payment in respect of remuneration.

It was contended that the payment was not a substitute for employment income due and payable; rather, it represented the impact on the taxpayer of not being able to work full-time as a result of the personal injuries sustained (arising from workplace induced stress, bullying and harassment), and the figure was made up of medical costs and future net loss of earnings.

Special damages

It was Revenue’s position that the payment described as ‘special damages of €95,000’ was a payment in respect of remuneration and, consequently, section 192A(5) applied to exclude the payment from exemption under section 192A(6) and, therefore, it was taxable under section 123 as a payment made on retirement or removal from office.

The appeal commissioner analysed the agreement and, in particular, the schedule of special damages. She stated at paragraph 14: “In considering if a payment made under an agreement has tax consequences, and as the terms agreed by the parties are embodied in the agreement, the agreement is considered as a whole with due regard for the words expressed in the agreement, which are words chosen by the parties.”

She observed the difference between general damages and special damages – the former broadly viewed as damages for pain and suffering (non-pecuniary loss) and the latter as pecuniary loss.

The settlement agreement provides for these separate categories and, in her view, the schedule of special damages sought to quantify the pecuniary loss due to the taxpayer arising from her High Court proceedings. The inclusion of medical expenses and miscellaneous expenses supported this view.

The appeal commissioner stated at paragraph 19: “The documentary evidence does not support the submission by the appellant that the payment of €95,000 was a compensation payment quantified by reference to salary only.

“The settlement agreement describes the payment as ‘special damages’ and the schedule of special damages refers to ‘loss of earnings’ for past and future losses. It is noteworthy that the schedule of special damages takes a deduction for the income earned by the appellant for her part-time employment in the quantification of loss of earnings.

“In my opinion, the schedule of special damages was a calculation to place the appellant as close as was practicable to that which the appellant would have enjoyed had the appellant had the earning capacity of full-time employment.”

Loss of earnings

The appeal commissioner went on to state that the statutory language in section 192A(5)(a) was broadly drawn. The payment was described by the parties as special damages and identified separately from the ‘damages for personal injury’.

The payment was further identified as ‘loss of earnings’ and was calculated with reference to the income the taxpayer would have earned if in full-time employment. If the taxpayer had been able to earn that income in the course of employment, that income would have been taxable.

For these reasons, the appeal commissioner was satisfied that so much of the payment described as ‘special damages’ and calculated as loss of earnings was a payment in respect of remuneration and, therefore, taxable accordingly. The exemption in section 192A did not apply.

Severance agreement

Decision 12TACD2020 concerned sections 123 and 192A(3). The agreement in this case was entitled ‘severance agreement’, which made provision for, among other things, a payment of €65,000 to the appellant taxpayer. Of significance in this case was that the severance agreement arose on foot of a mediation held between the taxpayer and his former employer prior to the issue of any legal proceedings.

During the course of his employment, the taxpayer made a formal complaint of bullying, which was investigated by an external investigator who did not uphold the complaint. The taxpayer was dissatisfied with the investigation and sought to appeal the findings.

By way of letter from his solicitor, clarity was sought as to the correct forum for that appeal. The solicitor sought confirmation that all internal appeal mechanisms were exhausted and whether all issues should be referred to the Labour Relations Commission for a hearing before a rights commissioner.

The taxpayer’s solicitor also raised the possibility of mediation, which subsequently took place, resulting in the aforementioned severance agreement.

It was Revenue’s position that the payment did not come within section 192A(3) and, consequently, was not exempt from income tax under section 192A(6). More specifically, the payment was not made under a mediation process provided for in a relevant act.

Out-of-court settlement

Revenue also submitted, among other things, that the payment did not attract the exemption as an out-of-court settlement as, for the payment to be an out-of-court settlement, the matter must be advanced to the point where there was a real prospect that the matter would be presented to a court for a decision.

The appeal commissioner determined that the payment made to the taxpayer did not qualify for exemption under section 192A(3). The terms of the severance agreement were clear and stated that the payment was made on the termination of the employment of the taxpayer.

While a successful mediation had taken place, there was no reference in the agreement to the payment being made by the employer for breach of employment rights of the taxpayer arising from his complaint of bullying.

The appeal commissioner stated: “Section 192A(3) provides that a payment may be exempt from tax if it is made with a settlement agreement arrived at under a mediation process provided for in a relevant act. There is no evidence that a claim was made by the appellant to a relevant authority.

“The mediation process between the appellant and the employer is not identified as a mediation process which has its origins in a relevant act. The evidence presented is the parties themselves agreeing to mediation. For the provisions of section 192A(3) to apply, the settlement should be arrived at under a mediation process provided for in a relevant act” (emphasis added).

Words with friends

It is worth bearing in mind that taxing statutes are construed strictly. Therefore, the wording of the section must be examined carefully. While there is often Revenue guidance on the interpretation of sections, it is only the wording of the section that can be examined and interpreted by an appeal commissioner.

A feature of both these cases is a reference to ‘out-of-court’ settlements. This point was recognised by the appeal commissioner in 12TACD2020, where she notes that the wording in the tax and duty manual published by the Revenue Commissioners refers to ‘out-of-court’ settlements; however, section 192A(4) makes no reference to such language.

In order to avail of the exemption, the section in this case requires that the payment is made “in accordance with a settlement arrived at under a mediation process provided for in a relevant act”.

Unless a taxpayer can rely on a specific provision in the employment legislation establishing the mediation was concluded under a provision of a relevant act, or produce a claim form to the appropriate forum, then it appears that the section will not apply.

These cases provide helpful guidance and clarity on two points in employment disputes concerning the termination of employment, namely, the description of any payment made and the mediation process.

It is clear that care must be taken when describing a payment in a settlement agreement. Revenue will look at the agreement as a whole and will look to the true nature of the payment and not simply the description thereof.

Secondly, care must also be taken when entering into the mediation process, and thought should be given as to when this is appropriate in terms of any termination payment that may ensue and whether section 192A(3) is complied with.