The case of S Mathur v HMRC [2022][1] demonstrates HMRC’s aggressive predilection to tax the seemingly untaxable. Ms. Mathur worked at a bank and her employment was terminated for ‘alleged misconduct’, although she contended it was a wrongful termination.
This matter was ultimately resolved by an agreement of £6 million to settle the Employment Tribunal (ET) proceedings that she had brought post-termination. The primary issue in this case was the interpretation of s401(1) (a) of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA)[2] which taxes: ‘Payments and other benefits which are received directly or indirectly in consideration or in consequence of, or otherwise in connection with— the termination of a person’s employment’. 3 The purpose of this article, not unlike that of the First Tier Tribunal (FTT) in Mathur, is to interpret ‘connection’ and ‘consequence’ without the benefit of substantial judicial guidance. Put simply, was the settlement agreement indirectly in consequence of the termination? Or was it otherwise in connection with the termination? The FTT unsurprisingly nodded through HMRC’s interpretation, but in doing so has left a statute which can apply endlessly to any ‘payment’ or ‘benefit’ which has even a whiff of connection to a termination.
So, what happened in the case? The findings by the FTT can be summarised as follows:
(i) The ET proceedings had various heads of claims including discrimination and termination.[3] The £6 million sum was arrived at by horse trading, thus Ms. Mathur’s schedule of loss (which included claims for unfair dismissal) in the ET played no part in the negotiations; the sum was not calculated by reference to sums claimed in the ET.[4]
(ii) The settlement sum was received by Ms. Mathur ‘directly in consequence’ of settling the proceedings and Ms. Mathur positioned herself as a ‘nuisance’, so the Bank paid the price for her to go away.
(iii) Lastly, based on the claims made by Ms. Mathur in the ET proceedings, the termination was a ‘trigger point, catalyst and enabling event’ (emphasis added) for the settlement and thus, the sum was ‘indirectly in consequence’ or otherwise ‘in connection’ with the proceedings and taxable.
This article criticises FTT’s broad approach and in the process attempts to embank the outer limits of s401(1)(a). It also aims to answer the subordinate questions which the court failed to ask itself when interpreting the statute: when a termination opens a new course of action (the settlement meeting), is the result in ‘consequence’ of the termination? Additionally, if the new action leads to a payment of a sum is the payment ‘connected’ to the termination?
The House of Lords authority in Barclays Mercantile Business Finance Ltd v Mawson, puts the ultimate question of statutory interpretation as, ‘whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically’.[7] Keeping that view in mind, the FTT held that the termination triggered the ET proceedings, which then led to a settlement agreement, thus forming a chain of indirect consequence. However, even if s401 is construed purposively one cannot disobey the laws of sentence formation, which in Mathur puts forth that ‘payments and other benefits which are received directly or indirectly … in consequence of … the termination of a person's employment’.[8] The sentence ties ‘direct and indirect’ to a consequence, that being the termination of employment. Thus, there cannot be any different channels or modes through which payments and benefits can be received post-termination, it must be consequential. The ‘trigger’ test put forth by the FTT does not encapsulate the wording of the statute, as it only looks at the transaction on a surface level and in the process confuses ‘sequential’ with ‘consequential’.
To demonstrate, if an employee is terminated and as a result gets the time to make a painting portraying the discrimination that they suffered during employment, would the proceeds of sale from that work of art be taxable under s401? If the FTT’s approach is followed, then the answer is yes because the proceeds are ‘indirectly a consequence’, since the termination ‘triggered’ the work of art. This interpretation is unduly wide. It disregards the parliamentary purpose of taxing payments ‘consequential’ to termination of employment, not merely payments which happen to be sequential to termination. Moreover, support for this interpretation can be found in the Oxford
English Dictionary’s definition of ‘consequence’ as ‘a thing or circumstance which follows as an effect or result from something preceding’,[9] it cannot be a result which ‘may’ follow or ‘sometimes’ follows the preceding event. In Mathur, the settlement was merely sequential to the termination, not consequential, as the sum of £6 million was just one of the many possibilities of issuing a claim. The settlement broke the chain of consequential relationships between the ET claims, termination, and payment since the former did not inform the latter. It therefore follows that the proper question to ask for consequential payments or benefits under s401(1)(a), is: whether the settlement sum is the result of the termination?
Peculiarly, the FTT says that ‘the termination was central to significant claims made by Ms. Mathur in the ET proceedings, and it is on this basis that s401(1)(a) can be satisfied’.[10] Nevertheless, there is no evidential basis for this assertion or the conclusion that the settlement sum was informed by the claims.[11] Faced with a situation not unlike ‘Schrödinger’s cat’,[12] as the settlement agreement is simultaneously informed by the ET claims and not informed by them forming a ‘superposition’ of the settlement, the FTT held ‘the exercise under s401 to be an ‘objective’ one and relied on the parties perceived intentions to justify the outcome’.[13] This could not be further from the wording of s401, which focuses on payments and benefits ‘received’ in a prescribed manner,[14] favouring the taxpayer’s perspective.
Proponents of the approach in Mathur might worry that if a subjective analysis were preferred it would lead to problematic tax avoidance and limit HMRC’s enforcement powers concerning termination payments. Such concerns are unfounded, however, as a subjective analysis would be preferred only where the basis of the settlement agreement is unclear. Secondly, if in such ‘Schrödinger’s Settlement’ situations, there are concerns of deliberate tax avoidance these would be caught by the General Anti-Abuse Rules (GAAR) under FA 2013, sections 206 – 215.[15] For Instance, in Mathur, the payment would have been consequential and thus taxable under s401 if the settlement sum was expressed as compensation for termination, as there would be no ambiguity for the basis for settlement.
With this prospective approach in mind, if the court were to ask itself what is the settlement sum a result of, the unequivocal answer on the evidence is that it is the result of Ms. Mathur’s ‘nuisance value’ rather than a consequence of her termination (wrongful or otherwise). This is not a novel approach. In Scott v Ricketts, Lord Denning held that, ‘selling an asset - namely, a legal claim - for a price was not an annual profit or gain within Case VI’.[16] The same treatment should be afforded to settlement agreements under s401 where a claimant sells their ‘nuisance value asset’ not unlike the painting.
The structure of s401 puts the phrase ‘otherwise in connection’ after ‘direct or indirect consequence’,[17] this casts a wider net than consequential receipts of termination payments, as is the approach favoured in HMRC v Colquhoun.[18] Following this, the FTT said, ‘If they are wrong on the settlement sum being consequential, it is otherwise in connection to the termination on the same factual matrix’,[19] they nevertheless have failed to provide a tenable legal test for the statute. The FTT contends that as the termination was a ‘trigger’ or ‘catalyst’ for the settlement sum it forms a sufficient connection to be taxable, however, a but-for test is not the correct approach. [20] These are similar concepts worded differently. If the termination is the trigger-but for the termination--the settlement would not have taken place.
Moreover, judicial precedent exists on the meaning of ‘otherwise in connection’ which contradicts the FTT’s approach. The first significant case, analogous to the situation in Mathur is Crompton v HMRC, where a connection was defined as, ‘a link, joint or bond between the compensation payment and the termination of the taxpayer's employment’.[21] In Crompton, the payment was for the selection boards' unfair treatment of the taxpayer but that did not lead to his leaving the army, thus there was no connection to the termination. Crompton represents one end of the spectrum, which can be contrasted with Moorthy v HMRC, where ‘an ex-gratia sum of £200,000 by way of compensation was for loss of office and employment’,[22] and the Court of Appeal held there was ‘otherwise a connection’ as the settlement was linked to termination and denied deciding the outer limits of the provision.[23]
To interpret whether the phrase requires a ‘strong and close nexus or a weak and loose one’,[24] the Court of Appeal in London Luton v HMRC looked at the context of the ‘connection’[25] for the BPRA legislation in Part 3A of the Capital Allowances Act 2001.[26] Thus, the interpretative exercise is context-specific, and cannot be achieved by removing ‘otherwise in connection’ from its structure to give it a wider meaning, as was done by the FTT in Mathur. It is ‘otherwise in connection’ when it is not directly or indirectly a consequence of the termination, which limits the reach of the provision. It is not some unspecified sequential connection, rather considering the approach for ‘consequential payments’ above. Rather, it needs to be a ‘causative connection’ like the one in Crompton. The sum in Mathur had a ‘link, joint or bond’ to the claimant’s nuisance value and effective negotiations with the Bank. However, one may argue that to alleviate the fears of the termination claim in the ET proceedings, the Bank might have paid some of the £6 million towards termination in Mathur. Moreover, the UT in Moorthy emphasized that, ‘even damages to reflect non-pecuniary matters fall within section 401 ITEPA if they are connected with the termination of employment’.[27] Nevertheless, such a connection must be causative to the value of the payment or benefit like in Moorthy. A ‘trigger’ should have been considered too distant and sequential a connection to be ‘causative’ to the value of the payment for s401.
Mathur advanced an unduly broad approach to the taxability of termination payments or benefits under s401. The FTT would do well to reconsider its expansive interpretation of the statute and in favour of a more nuanced understanding of the terms at play. The settlement in Mathur was not genuinely ‘in consequence’ of the termination or ‘sequential’ to it. The termination opens a new course of action, the result stemming from the action is unlikely to be a ‘consequence’, direct or indirect for s401. Furthermore, the FTT forwarded a skewed interpretation by relying on an ‘objective’ analysis in cases of ambiguous settlements. It should instead adopt a more taxpayer-friendly approach. Moreover, in considering the phrase ‘otherwise in connection’, the FTT's approach lacked a clear legal test for this aspect of s401. Drawing on Crompton and Moorthy, a ‘causative connection’ should be required in interpreting s401 such that a payment resulting from a ‘new action’ is unlikely to be causative of termination. At the very least, the decision in Mathur highlights the need for a more precise and context-specific interpretation of s401 to avoid overreaching its intended scope.
[1] UKFTT 88 (TC) (9 March 2022).
[2] Income Tax (Earnings and Pensions) Act 2003 (ITEPA), s401(1)(a). 3 Mathur (n 1) [89].
[3] ibid [16].
[4] ibid [47].
[5] ibid [88] & [112].
[6] ibid [113] – [115].
[7] [2004] UKHL 51, [2005] 1 AC 684 [36].
[8] ITEPA (n 2) s 401 (1) (a).
[9] Oxford University Press, 'Consequence (n)' (Oxford English Dictionary, September 2023).
https://www.oed.com/search/dictionary/?scope=Entries&q=consequence accessed 30 December 2023.
[10] Mathur (n 1) [122].
[11] ibid [47], [88], [122].
[12] E. Schrödinger, "Die gegenwartige Situation in der Quantenmechanik," Naturwissenschaften 23 (1935) 807.
[13] Mathur (n 1) [90].
[14] ITEPA (n 2) s401(1).
[15] Finance Act 2013, ss 206 – 215.
[16] [1967] 44 TC 303 [5].
[17] ITEPA (n 2) s401(1)(a).
[18] [2011] STC 394 (UT) [11] [12].
[19] Mathur (n 1) [119].
[20] ibid [120].
[21] [2009] UKFTT 71 (TC), [34], [35].
[22] [2016] UKUT 0013 TCC [2].
[23] Mathur v HMRC [2018] STC 1028 [48] (Henderson LJ).
[24] Coventry and Solihull Waste Disposal Co Ltd v Russell (Valuation Officer) (“Coventry Waste”) [1998], RA 427.
[25] [2023] EWCA Civ 362 [55] – [69].
[26] Capital Allowances Act 2001, s360B (1).
[27] [2016] UKUT 0013 TCC, [54].