Taxation and compensation

Case 9: The facts

Stephen Clayton and other council employees were contractually entitled to an "essential car user" allowance. The council wanted to withdraw the allowance and asked for the employees' agreement. Clayton and some colleagues refused; their contracts were then terminated and they were given new employment contracts.

The employees successfully brought claims for unfair dismissal. Before the remedies hearing, a settlement was negotiated and they were reinstated on their original terms. They received compensation for the lost allowance as well as basic awards. The issue was whether the compensation was taxable.

The ruling

Compensation for unfair dismissal is not an "emolument" (earnings) for tax purposes and is tax-free up to £30,000. The Court of Appeal held that the payments did fall into this category and were not taxable. The fact that the claimants received more than they would have done at a remedies hearing was irrelevant.

Wilson (HM Inspector of Taxes) v Clayton [2005] IRLR 108