No tax relief for lawyers' success fee in case against the Met

In HMRC v Keith Murphy [2022] EWCA Civ 1112, the Court of Appeal decided that a success fee and indemnity premium to be paid out of an employment-related compensation settlement were not deductible for PAYE. Neither cost was incurred necessarily in the performance of the employee's duties as a serving police officer.

• Mr Murphy and a group of other officers of the Metropolitan Police (the Met) sued the Met for unpaid overtime and other employment allowances.
• They agreed to pay their solicitors and barristers a success fee, should they win and they also took out indemnity insurance to cover their Legal Fees, should their case fail.
• The Met officers were successful in their litigation and the court ordered payment of costs, by the Met, their employer, which went directly to the legal teams together with a compensation payment of £4.2million payable to the officers.
• The officers paid the success fees and the indemnity insurance out of their compensation payment. The Met applied PAYE to the gross compensation received.
• Mr Murphy claimed that the success fees and indemnity insurance were deductible costs from the compensation payment, and claimed tax relief under Self Assessment on his 2017 tax return.
• Mr Murphy’s advisers had been in contact with HMRC with regard to the tax treatment, but HMRC decided that the correct treatment would be to spread the assessment over the years 2009 to 2016. HMRC opened a Discovery Assessment on that basis.

On Appeal, the First Tier Tribunal found that the success fees and indemnity insurance premium were not deductible.

The Upper Tribunal reversed that decision in favour of the taxpayer.

HMRC appealed to the Court of Appeal (CoA).

The COA, in overturning, the decision of the Upper Tribunal found that:

• The compensation payment for loss of overtime and employment rewards was agreed by the parties as taxable as employment income.
• The payment of costs, under a costs order made by the court, and paid directly by the Met to the successful legal team was also agreed as non-taxable as this reflected the work of those legal teams.
• The cost of the success fee and indemnity fee was incurred by the taxpayer directly and the settlement had been increased by some £200,000 by the parties to allow for tax on these sums. These did not pass the basic test for deduction of expenses by an employee, as the amount was not incurred necessarily in the performance of the duties of the employment.

HMRC's appeal succeeded, there was no deduction for the extra costs.

Useful guides on this topic

Legal fees
When can an employee deduct the cost of legal fees when taking action against their employer?

Reimbursed expenses and allowances
When are expenses or amounts that are paid or reimbursed to an employee exempt from tax?

Termination, redundancy and leaving payments
How are redundancy and termination payments taxed? What amounts can be paid tax-free? What amounts are taxable as earnings?

How to appeal an HMRC decision
Disagree with a HMRC decision? How to appeal, what type of decision can you appeal and what are your different options when you disagree with HMRC? What are the key steps in making an appeal?

External links

HMRC v Keith Murphy [2022] EWCA Civ 1112