Although not desirable, it is not unusual for an employee to raise a personal grievance with their employer. Section 123 of the Employment Relations Act 2000 (ERA) provides for a number of remedies where an employee has a personal grievance.
If an employee suffers humiliation, loss of dignity, or injury to feelings one remedy is for a compensatory payment to be made, whether as part of a court ordered award or an out of court settlement.
The question often then arises regarding how the payment should be treated from a tax perspective. Depending on the circumstances, such compensation is not considered to be derived "in connection with employment" and is therefore non-taxable, and there is no requirement to withhold PAYE. However, because the treatment is very fact specific it is common for payments that are treated as non-taxable to be reviewed by Inland Revenue or as part of a due diligence process. Because of that potential scrutiny it is important to have key documentation, guidance, and evidence to support the treatment adopted.
In June 2006, Inland Revenue released BR Pub 06/05 providing further commentary on the topic. The key conclusion from the commentary is that payments that are genuinely and entirely for compensation for humiliation, loss of dignity, or injury to feelings, under section 123(1)(c)(i) of the Employment Relations Act 2000, do not meet the definition of income per section CE 1 of the Income Tax Act 2000, and PAYE does not apply.
The IRD’s view in this publication is that there must be sufficient evidence to prove that firstly, there is the presence of a genuine Personal Grievance, secondly, that there is a sufficient nexus between the amount paid and the severity of the claim, and thirdly, that the payment made is entirely tied to the grievance and not another statutory payment obligation.
One of the key areas of this section is determining whether the payment is genuinely and entirely in relation to the Personal Grievance. Payments made under section 123(1)(c)(i) are a benefit in money. An employer would therefore need to demonstrate that the payment was not actually made “in connection with the employment or service” of the recipient. For example, a payment which is in substance based on lost wages, but labelled for ‘humiliation’ would be at risk of being taxable.
In Inland Revenue’s view there needs to be valid and documented proof of the Personal Grievance which would usually require an admission in writing by the employer that they acted in a manner that was unfair or unjust.
However, in a settlement scenario it is common for the employer to not make such an admission and often have asserted otherwise, and therein lies the ‘catch 22’. In the absence of an admission, it becomes very difficult to demonstrate that a payment is for humiliation, loss of dignity, or injury to feelings.
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