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HMRC internal manual

Employment Income Manual

Termination payments and benefits: example: calculation of damages: the Gourley principle

Under the employment contract, the employer must make a payment in lieu of notice of termination of employment is not given. A payment of 6 months’ pay (£25,000) is due in those circumstances (see EIM12976).

Since entitlement to the full payment arises on termination, it represents earnings within s62 ITEPA 2003 and is treated as received for tax purposes at that time (see EIM42260).

However, the parties assume wrongly that the payment is not earnings but is damages for breach of contract and so within Section 401 ITEPA 2003. Following the Gourley principle (see EIM13070) they agree a payment in settlement of £12,500. The reduction reflects adjustments due to mitigation as well as differences in tax and NIC between earnings and damages.

Since the payment is less than £30,000, it is paid without deduction of tax (see EIM13505).

The consequences are:

  • a determination is made on the employer to collect the £10,000 (£25,000 x 40%) that ought to have been deducted under the PAYE Regulations (the employee was liable at HR and the payment is treated as received before the P45 was issued) and
  • £10,000 is due from the employee, but that is satisfied by the credit for the tax that the employer was obliged to deduct
  • A Notice of Decision under s8 Social Security Contributions (Transfer of Functions Etc) Act 1999 will also be made to recover any Class 1 NICs dueThe employee protests at being out of pocket, having received only £12,500. If the employer had acted correctly the employee would have received £15,000 after tax.

Any adjustment is a matter for the parties, not HMRC. The Gourley principle is to do with the calculation of damages under non-tax law and is not a matter that HMRC can become involved with.