Court of Appeal decides costs deducted from settlement agreement payment were taxable as earnings (HMRC v Keith Murphy)

In HMRC v Keith Murphy, the Court of Appeal found that an amount paid by an employer to settle an employment law claim was taxable. The fact that some of that money was used to pay the claimants’ legal costs, or that it was paid by the employer on the claimants’ behalf to a third party, did not change the character of the payment as earnings.

HMRC v Keith Murphy [2022] EWCA Civ 1112

The taxpayer, together with other police officers, had brought a claim against their employer, the Metropolitan Police, for unpaid overtime. To fund their own legal costs for those proceedings, the claimants entered into an agreement with their lawyers which provided for a ‘success fee’ based on a percentage of any settlement amount. They also took out insurance against the risk of having to pay the Met’s legal costs. In the event, the Met settled the substantive claims out of court, agreeing to pay the claimants some £4.2m plus ‘agreed costs’.

Under the settlement, the success fee and insurance premium were not part of the ‘agreed costs’. They would instead be deducted from the £4.2m and paid directly by the Met. The remaining balance would be paid to the claimants and would be subject to PAYE and NICs. The Met applied PAYE to the whole of the settlement sum including the part representing the success fee and insurance premium. The question was whether those two elements were derived from employment and should therefore be treated as earnings. The Upper Tribunal had decided in the taxpayers’ favour.

Allowing HMRC’s appeal, the Court of Appeal held that the whole sum represented remuneration for the taxpayers’ services and was taxable. Crucially, the payment did not cease to be taxable as a result of the recipients using some of the money to pay their own expenses.

Sometimes it is the simplest words which can create the knottiest tax problems. Here the words were ‘from’ and ‘profit’. The court held that the full amount received was ‘from’ the employment and that the word ‘profit’ in the phrase ‘gratuity or other profit or incidental benefit’ in the statutory definition of earnings did not mean net or economic profit. It simply meant a benefit derived from the employment.

The judgment helpfully strips the key tests back to their essentials and navigates through the complexities, and occasional inconsistencies, of the extensive case law in this important area.

Case details

• Court: Court of Appeal, Civil Division
• Judges: Lord Justice Lewison, Lord Justice Newey and Lady Justice Andrews
• Decision date: 4 August 2022

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Formed in 2017, following significant legislative changes designed to increase competition within the legal services marketplace, Pro Employment Law is a progressive set of barristers’ chambers, consisting only of experienced employment law barristers, offering a full range of specialist advisory, case management, and advocacy services directly to the public through the Public Access scheme. We supply our legal services exclusively in the area of Employment Law to clients located across England & Wales. All of the legal services we supply are covered by professional indemnity insurance with Bar Mutual.