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Where Taxpayers and Advisers Meet

VAT and tax on a settlement payment?

Womble7
Posts:8
Joined:Wed Jan 13, 2021 11:47 am
VAT and tax on a settlement payment?

Postby Womble7 » Mon Mar 27, 2023 5:08 pm

I am a VAT-registered sole trader. A company I worked for gave me a settlement payment to drop my employment tribunal claim for worker or employee status - which would have given entitlement to holiday pay and compensation for unfair dismissal when the work arrangement was terminated. The claim also included unpaid invoices for previous work. The settlement payment was received gross but there was no mention of VAT. Is VAT, tax and/or National Insurance owed on the payment? Is VAT due on the amount covered by the unpaid previous invoices but not on the rest of the payment for withdrawing the tribunal claim? Is the latter element also free of tax and NI?

pawncob
Posts:5082
Joined:Wed Aug 06, 2008 4:06 pm
Location:West Sussex

Re: VAT and tax on a settlement payment?

Postby pawncob » Tue Mar 28, 2023 2:07 pm

https://www.gov.uk/hmrc-internal-manuals/vat-supply-and-consideration/vatsc05910

It is therefore essential that there is a direct link between the consideration and the supply. Where this is the case the supplier will normally have clearly agreed to do something for the customer in return for a payment. It may occasionally be the case that where an agreement does not explicitly allow a customer to do something the economic reality of the transaction is such that agreement to supply something is nevertheless effectively there

https://www.bdo.co.uk/en-gb/insights/tax/vat-and-indirect-taxes/vat-may-now-be-due-on-compensation-payments

or
A payment in respect of a loss of income is not specifically exempt from income tax. It is generally quite easy to determine an income receipt. For example, compensation for loss of earnings is a payment directly linked to the income of the recipient. It is generally accepted practice that compensation for loss of earnings should be claimed in respect of the net loss after tax. The employee should be put back into the same financial position that they would have been in, had they worked – that is, the loss of net pay.

The compensation payment will then be treated by HM Revenue & Customs as exempt in the hands of the recipient. This is known as the Gourley principle. Compensation that is claimed and paid gross is generally considered by HMRC to be taxable, because it is in excess of the actual financial loss suffered and thought to contain some element of reward – otherwise the employee is actually better off than if they had worked.

Consider an individual who has suffered because of a breach of contract and that individual has a right to take action as a result. The right to take action for compensation is a chargeable asset and the ‘disposal’ of that asset, that is, the settlement of the claim, may be a chargeable capital event. The taxability of the compensation then depends on how the right to take action arose.

Compensation for personal suffering and injury is exempt from capital gains (and income) tax. The exemption applies to ‘compensation or damages for any wrong or injury suffered by an individual in his person or in his profession or vocation’. HMRC sets a wide definition of injury, so that damages or compensation for ‘distress, embarrassment, loss of reputation or dignity’ such as unfair discrimination and defamation are not chargeable.

By concession, HMRC provides reliefs and exemptions for compensation which is chargeable to capital gains tax.
With a pinch of salt take what I say, but don't exceed your RDA

Womble7
Posts:8
Joined:Wed Jan 13, 2021 11:47 am

Re: VAT and tax on a settlement payment?

Postby Womble7 » Tue Mar 28, 2023 3:09 pm

Thanks for this. The settlement payment was higher than the unpaid invoices, but less than the backdated holiday pay and compensation for termination I would likely have been entitled to. So does that create the link between consideration and supply for VAT purposes, or not? There was VAT on the unpaid invoices, so do I just pay that VAT liability with the rest of the settlement payment being VAT-free (even if still liable for tax and NI)?

pawncob
Posts:5082
Joined:Wed Aug 06, 2008 4:06 pm
Location:West Sussex

Re: VAT and tax on a settlement payment?

Postby pawncob » Tue Mar 28, 2023 4:02 pm

VAT is due on the unpaid invoices.
As the claim was regarding employment rights, I suspect it's all taxable.
https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim12960
With a pinch of salt take what I say, but don't exceed your RDA

Womble7
Posts:8
Joined:Wed Jan 13, 2021 11:47 am

Re: VAT and tax on a settlement payment?

Postby Womble7 » Tue Mar 28, 2023 4:53 pm

But VAT would only be due on the unpaid invoices ie. not on the rest of the settlement?


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