Since 6 April 2018, section 406(2) of ITEPA 2003 says the tax exemption for injury does not cover injured feelings. So a payment for injury to feelings that is connected with the end of an employment is taxed like other termination compensation, with only the first £30,000 of the combined package free. A payment that relates solely to discrimination before the employment ended is outside the termination rules altogether and, on HMRC’s guidance, is not taxable.

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What changed in April 2018?

Section 406 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) takes payments made on account of injury to, or disability of, an employee completely outside the termination payment rules. Before 2018 some advisers argued that compensation for distress in a discrimination claim was compensation for an “injury” and so fully exempt. Finance (No. 2) Act 2017, section 5, added subsection (2) to section 406, which now reads that although injury includes psychiatric injury, it does not include injured feelings. HMRC’s manual at EIM13610 says the legislation introduced on 6 April 2018 confirmed its longstanding view.

The change followed the litigation in Moorthy v HMRC. In that case the Court of Appeal ([2018] EWCA Civ 847) held that compensation was within the termination payment charge because the dismissal itself was the discriminatory act, but the amount attributable to injury to feelings was exempted under the version of section 406 then in force. HMRC notes at EIM12965 that those provisions have since been amended, so that route is no longer open for payments made after the change.

The practical result is that the label “injury to feelings” no longer brings an exemption on its own. What decides the tax is whether the payment is connected with the termination.

When is an injury to feelings payment not taxable at all?

Section 401 ITEPA charges payments received “in consideration or in consequence of, or otherwise in connection with” the termination of employment, or a change in duties or earnings. HMRC’s guidance at EIM12965 says that where compensation for injury to feelings can reasonably be attributed solely to discrimination that happened before the termination, it should be accepted as not connected with the termination and outside section 401. Nothing else in the Act taxes it, so it is free of income tax and National Insurance.

HMRC cites Walker v Adams (SpC 344). The employee accepted £77,446 after a constructive dismissal based on religious discrimination: £12,500 for injury to feelings and £64,947 for loss of earnings. The loss of earnings element was taxable as a termination payment, but HMRC accepted that the £12,500 was not taxable because all the discrimination took place before the termination.

The same reasoning covers a claim settled while the employee stays in the job. If there is no termination and no change in duties or earnings, section 401 has nothing to bite on, although any element that replaces pay the employee should have received is still taxed as earnings.

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When is it taxed?

If the dismissal itself was the discriminatory act, the injury to feelings payment is connected with the termination and falls within section 401. That was the position in Moorthy, where there had been no earlier discrimination during the employment. Section 401 amounts are taxable only above the £30,000 threshold in section 403, and that threshold is shared across every section 401 payment from the same employment and associated employers (section 404).

Where there was discrimination during the employment and the dismissal was also discriminatory, HMRC says the facts must be examined and the payment apportioned between the two. Taxpayers sometimes rely on Oti Obihara v HMRC, where the First tier Tribunal held that section 401 did not apply to non financial losses. HMRC points out that the Court of Appeal in Moorthy said that case was decided on an incorrect statutory test and should not be followed.

How much can be attributed to injury to feelings?

A settlement cannot make a payment tax free simply by calling most of it injury to feelings. The Court of Appeal in Moorthy confirmed that the amount attributed must be proportionate to the Vento guidelines, the bands employment tribunals use to value injury to feelings awards. On that basis only £30,000 of the £200,000 Mr Moorthy received could be treated as injury to feelings, and at paragraph 79 the court warned against seeking exemption for much larger sums under the guise of a discrimination settlement.

HMRC says it will apply the Vento guidance in force on the date the settlement agreement is signed. It also says best practice is for the agreement to set out what each element of the payment is for. Where a single sum is paid “in settlement of all claims”, the facts are examined and a reasonable apportionment agreed, and if the agreement relates partly to termination the onus is on the taxpayer to show that a payment is not connected with it.

Can the injury exemption still apply?

Yes, for genuine injury. Section 406(2) keeps psychiatric injury within the exemption. HMRC’s guidance gives the example of an employer whose actions have caused a mental health condition such as stress, anxiety or depression that affects the individual’s ability to work. That compensation is within section 401 but may be exempt under section 406(1)(b). To qualify, the condition must prevent the employee from carrying out the duties of the employment and medical evidence must be provided. The tests are covered in our page on the injury and disability exemption on termination.

What National Insurance is due?

From 6 April 2020 employers pay Class 1A National Insurance on termination awards above £30,000 that are taxed under section 403 and are not already earnings for Class 1 purposes. There is no employee National Insurance on these amounts, and the Class 1A charge mirrors the income tax position (NIM13201). An injury to feelings payment that sits outside section 401 is therefore free of Class 1A as well as income tax. See National Insurance on termination payments and Class 1A National Insurance.

How does this work in practice?

Illustration only. An employee suffers harassment for a year, raises a grievance and is then dismissed. The settlement agreement pays £50,000, attributed as £10,000 for injury to feelings caused by the harassment during employment and £40,000 for loss of the job and future earnings. There is no notice pay, holiday pay or other earnings element.

  • The £10,000 relates solely to discrimination before the dismissal, so it is outside section 401 and not taxed.
  • The £40,000 is a section 401 payment. The first £30,000 is free of tax; the employer operates PAYE on £10,000 and pays Class 1A on £10,000.

Now change the facts so that the only discriminatory act was the dismissal itself. The £10,000 for injury to feelings is connected with the termination, so all £50,000 is within section 401 and £20,000 is taxable. The amount of the award is the same; the tax depends on what the injury to feelings payment was for.

What mistakes come up most often?

  • Treating injury to feelings as an exempt injury. Since 6 April 2018 section 406(2) rules this out.
  • Inflating the injury to feelings figure. HMRC expects the amount to be proportionate to the Vento bands at the date of signing.
  • Not attributing the payment. A single sum “in full and final settlement” invites an apportionment that the taxpayer must then justify. Our page on settlement agreements covers the other elements.
  • Missing earnings elements. HMRC says compensation for historic loss of pay, such as unequal pay, takes the character of the pay it replaces and is taxed as earnings under section 62, as in Pettigrew v HMRC. Payments for restrictive undertakings are taxed in full under section 225.
  • Forgetting the shared threshold. The £30,000 covers all section 401 payments together, as explained in tax on termination payments.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 24 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.