Hampshire accountant issues warning on tax rules around compensation

Michaela Johns, director at Chandler’s Ford-based HWB Chartered Accountants, said aspects of the payout scheme set up in the wake of the Horizon IT case had relevance for both employers and employees.

She said: “For companies, care must be taken to ensure any tax relief claimed on a compensation payment is lawful.

“While you can claim a corporate tax deduction for a legitimate expense, if it is related to a penalty or a fine the tax authorities will not generally allow it. The argument is that you shouldn’t be able to claim a tax benefit in a situation where you have broken the law.”

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The question of when a compensation payment can be tax-deductible has come to the fore after it was revealed that the Post Office claimed tax relief on payments made to sub-postmasters forced to stump up cash for thefts they were wrongfully accused of, due to the Horizon software.

Michaela said: “We await a definitive ruling from HM Revenue & Customs on this, but right now there is considerable doubt as to whether such compensation payments, made to victims in the midst of this scandal, are tax-deductible.

Michaela Johns, director of HWB Chartered Accountants (Image: Deep South Media)

“If the decision goes against the Post Office, it could face a £100m fine. It’s analogous to a case HMRC won last year against an energy firm which established that you can’t claim a tax deduction for compensation payments made over mis-selling.

“There are many examples of expenses which are tax-deductible, including legal costs in relation to compensation schemes, but companies should always be clear what is and what isn’t permitted, so they can stay on the right side of the law.”

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“In general, compensation paid for loss of income is not specifically exempt from income tax. It is a common misconception that £30,000 of any such payment is exempt, but this is only the case if the payment meets a condition, for example, is ex gratia.

“If the payment is actually contractual or customary, this can instead be treated as earnings and is therefore taxable accordingly under PAYE.

“It just goes to show how complicated the tax rules are. If you are someone who has received a compensation payment, it’s important to find out whether or not it has had tax deducted from it already and hence what to declare on your return.”