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HMRC internal manual

Employment Income Manual

Termination payments and benefits: Section 401 ITEPA 2003: exceptions: payments on account of injury or disability: typical scenario

Section 406(b) ITEPA 2003

The following illustrates a typical scenario for a disability payment.

An employer has a policy with an insurer which provides monthly payments to the employer in the event of named employee’s sickness absence. The employee’s contract provides that these payments are passed on to the employee. They are taxed as earnings under s221 ITEPA 2003 (sickness payments).

After some years, medical reports indicate that the employee is never going to be capable of returning to the job. Since the monthly payments will continue to the employee’s normal retirement date, the insurer suggests commuting its liability to the employer in return for a lump sum. This sum will relate to the insurer’s expectations of the future due payments adjusted for factors such as early payment and uncertainty, The employer receives this sum and pays the same amount to the employee as part of an agreement under which the employment is terminated.

If the employee is young or a high earner, the lump sum may be very large. Size is of itself no bar to the exception but see EIM13640 to check whether a report is required to be made to Employment Income Technical.