EIM13995 - 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).

The parties assume that Section 401 ITEPA 2003 will apply to the payment and, since it is less than £30,000, it will be free of tax (see EIM13505). Consequently, following the Gourley principle (see EIM13070) the payment is agreed to be reduced to £15,000 (£25,000 less higher rate tax at 40% of £10,000).

The assumption is incorrect as Section 62 ITEPA 2003 applies (see EIM12976), so:

• a determination is made on the employer for the £3,450 that ought to have been deducted under the PAYE Regulations (since the employment had terminated when the payment was made, the deduction is of basic rate tax only: £15,000 x (say) 23% = £3,450) and
• £2,550 is demanded from the employee who is liable at higher rate (£15,000 x 40% = £6,000 less (credit for PAYE tax that ought to have been accounted for) £3,450 = £2,550).

The employee protests at being out of pocket, having suffered an adjustment for tax when the payment was calculated, then being taxed on the result.

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. £15,000 has actually been paid.

Assume that the employer then agrees that the payment should have been £25,000 and so makes an additional payment of £10,000. That is within Section 62 ITEPA 2003 (see EIM12976) and basic rate tax of £2,300 should be deducted. The ex-employee is assessed on £10,000 at 40% = £4,000 and given credit for PAYE tax of £2,300.