Exemption from Income Tax in respect of Certain Payments under Employment Law

Section 192A of the Taxes Consolidation Act 1997 (the “TCA”), provides for an exemption from income tax in respect of certain payments made as a result of an employee’s rights and entitlements having been infringed through, for example, discrimination, harassment or victimisation.

 

The exemption applies to both:

• Payments arising out of claims made under a “relevant Act” following a formal hearing before a “relevant authority” (or through a mediation process provided for under the Employment Equality Acts 1998-2015), on foot of a recommendation, decision or determination by that relevant authority. A “relevant Act” is an enactment which contains provisions for the protection of employees’ rights and entitlements or for the obligations of employers towards their employees, while a “relevant authority” includes the Workplace Relations Commission, the Labour Court and the civil courts.
• Subject to certain conditions, payments made under an out of court settlement, in place of a formal hearing outlined at (a), which has been agreed between an employee and his or her employer.

In applying the exemption, there is an important distinction between salary/wages (which are taxable) and compensation for a wrong done which is quantified by reference to salary/wages (which may qualify for the tax exemption). For example, compensation in respect of claim under employment related law relating to harassment, which may qualify for the tax exemption, may be quantified as being not more than, say, 26 weeks’ wages.

 

The exemption specifically does not apply to payments in respect of:

• actual remuneration or arrears of remuneration arising from a claim under a “relevant Act”;
• the termination of employment;
• compensation for a reduction or possible reduction in future remuneration arising from a reorganisation of a business or changes in work procedures, work methods, or a change of location where the duties of the employment are;
• compensation under a court order under section 2B of the Employment Permits Act 2006.

 

Revenue Guidance on Taxation of Out of Court Settlements

While the tax treatment of awards made after a formal hearing is relatively straightforward and uncontroversial, the tax treatment of out of court settlements is a little more complex. For an out of court settlement to qualify for the exemption under section 192A of the TCA, it must meet all of the following conditions:

1. the agreement must be evidenced in writing;
2. the original statement of claim by the employee must be evidenced in writing;
3. the agreement must not be between connected persons as defined in the TCA (for example, between an employer and a relative);
4. the claim would have been a bona fide claim under a “relevant Act” had it been made to a “relevant authority”;
5. the claim is likely to have been the subject of a recommendation, decision or determination by a relevant authority that a payment be made to the person making the claim;
6. the payment does not exceed the maximum amount which could have been awarded under relevant legislation by the Workplace Relations Commission or Labour Court as appropriate.

Employers are obliged to retain copies of any such agreements together with the employees’ statements of claims for a period of six years from the date the payment was made, and to make these documents available to Revenue when requested to do so.

 

Updates to Revenue Guidance on Taxation of Out of Court Settlements

It is in relation to the taxation of out of court settlements that Revenue Guidance has recently been updated. The updated Guidance states that, in considering if the exemption applies, due regard must be had to all terms and clauses included within any written agreement between the parties. This includes any terms which attribute or apportion the payment between different elements of the claim.

It further states that where the agreement does not clearly attribute the payment to any specific element of the claim, the classification and consequential tax treatment of the payment must be determined having due regard to the full facts and circumstances of the case and the terms of the agreement reached between the parties.

Therefore, careful consideration of the case and the detailed terms of the settlement agreement must be considered in determining whether the payment made thereunder qualifies for the exemption under section 192A of the TCA. On a cautionary note, where the availability of the exemption has formed a key part of an agreement being reached, and on the basis of the requirement described at paragraph (5) above (claim likely to have been the subject of a decision that a payment be made), the parties to any such agreement, and in particular employers, may have to accept that they should no longer insist upon standard clauses denying liability forming part of the agreement as such a clause may be interpreted by Revenue as contrary to the requirement of paragraph (5).  Ultimately, whether a pro forma denial of liability denies parties access to the exemption is something a Court may be asked to determine.

In order to be exempt from income tax, a settlement payment must be attributed to a specified breach or breaches of employment legislation. Where the settlement payment is in respect of a claim comprised of different elements, the payment should be clearly allocated between each of the different elements covered by the settlement agreement.

The updated Guidance acknowledges that the format of the employee’s original statement of claim, which must be evidenced in writing, and the details to be included in it, will vary depending on the facts and circumstances of each individual case. However, such documentation is expected to include information on the nature of the claim, the nature of the relationship between the parties involved or a high-level summary of the allegations, along with their impact.

It confirms that the employee does not need to engage an external advisor to prepare the documentation on their behalf and that there is no requirement for the statement of claim to have been formally submitted to a relevant Authority, provided all other conditions are met.

The position remains that there is no obligation on employers to obtain prior Revenue approval for an exemption under section 192A of the TCA in respect of out of court settlements.

Employers are urged to give careful consideration to each individual case and the detailed terms of the settlement agreement reached in determining whether the payment made thereunder qualifies for the exemption under section 192A of the TCA, as otherwise there may be an underpayment of taxes with consequent implications for the employer.