Compensation For Humiliation, Loss Of Dignity & Injury To Feelings

Compensation For Humiliation, Loss Of Dignity & Injury To Feelings

Introduction: Compensation for humiliation, loss of dignity or injury to feelings are tax free

The Employment Relations Act 2000 provides for a number of remedies when an employee has a personal grievance against a current or former employer. These remedies include compensation for humiliation, loss of dignity or injury to the feelings of the employee, which are provided for under section 123(1)(c)(i) of that Act. A binding Public Ruling issued by IRD in 2006 provides that awards or out-of-court settlements that are genuinely and entirely compensation for humiliation, loss of dignity and injury to feelings under section 123(1)(c)(i) are classified as tax-free capital payments and are therefore not included in an employee’s taxable income. The rationale behind that ruling was that such payments are not a reward for the employee’s services but rather a recognition of the wrong done to the employee and therefore cannot be regarded as “employment income”.

When will the IRD challenge section 123(1)(c)(i) compensation for humiliation?

The Public Ruling issued by the IRD provides that this tax-free status does not apply to sham payments, which are transactions set up to conceal the true intention of the parties. The consequence is that, if the parties to an agreement characterise or describe payments as being for humiliation, loss of dignity or injury to feelings when they are in reality for lost wages, this transaction would be open to challenge by the IRD. While genuine compensation for humiliation, loss of dignity or injury to feelings is not taxable in the hands of the employee, it will generally be tax deductible to the employer. This one-sided tax treatment provides a strong incentive for parties to classify payments as section 123(1)(c)(i) compensation for humiliation payments. As a result, IRD aggressively polices payments made under that section.

Employee with hurt feelings

“It appears as though the Authority or Court tends to apply a $5,000 starting point and adjust upwards or downwards depending on the evidence of the degree of emotional harm in each case. “.

The principles as to when a compensation for humiliation payment under section 123(1)(c)(i) will be considered genuine and when it will be considered a sham have never been fully articulated. However, the Taxation Review Authority has made it clear that “seemingly excessive allocations to compensation for feelings injury should be reopened by the IRD”. The Employment Court in Salt v Fell established the method a Court must follow when assessing such payments. In that case, it was affirmed that remedies should reflect the actual loss suffered by the employee. Since the loss being compensated for under section 123(1)(c)(i) is non-monetary, the Authority or Court must make an assessment of the appropriate level of compensation by conducting a two-stage approach:

  1. Firstly, the Court must look at the evidence of the actual distress suffered by the employee and form an impression of it.
  2. Secondly, the Court must have regard to awards made in comparable cases and ensure that there is a reasonable degree of consistency. Like cases should be treated similarly.

Where IRD challenges a compensation for humiliation payment made under section 123(1)(c)(i) as being not genuine or excessive, the onus is on the parties to the agreement to justify the payment made. The parties must be able to demonstrate that the amount paid to the employee was reasonable given the facts and the level of compensation awarded by the Courts in similar scenarios.

An example of a settlement that was subsequently challenged involved a compensation for humiliation payment made under section 123(1)(c)(i) of $48,600. An inquiry showed that the former employee’s annual salary had been precisely $48,600 and that there was no provision in the settlement for lost remuneration. That led to the conclusion that this transaction was a sham.

Quantum: How is compensation for humiliation under section 123(1)(c)(i) calculated?

There is no clear set of principles, either in statute or in the case law, as to how compensation for humiliation under section 123(1)(c)(i) is to be calculated. Nevertheless, it is helpful to turn to the case law to determine the broad parameters of the awards made under this section.

Case law indicates that, over the last 10 years, the average award has been between $5,000 and $6,000, only 10% of cases were awarded over $10,000 and compensation awards of more than $40,000 are very rare. It appears as though the Authority or Court tends to apply a $5,000 starting point and adjust upwards or downwards depending on the evidence of the degree of emotional harm in each case. Although each case is unique and the award in each case must depend on the emotional harm to the employee, the Courts have repeatedly emphasised the need for consistency of awards and moderation in their amounts.

Recent trends

Recently, however, there has been concern that the awards for humiliation given under section 123(1)(c)(i) are not adequately compensating the employee.

In the recent decision of Hall v Dionex Pty Ltd, the Employment Court observed that compensatory awards had been stagnant for the last 20 years. In that case, the Court resisted the temptation to award compensation consistent with previous awards. In doing so, the Court observed that, although there was a need for a degree of consistency, there was a danger of this consistency keeping compensation awards artificially low.

In Rodkiss v Carter Holt Harvey, the Court followed the approach adopted in Hall v Dionex “to fix a fair and reasonable amount of compensation bearing in mind the need in this jurisdiction for moderation in such awards”.

Time will tell whether these two recent judgments provide an impetus for compensation awards to increase.

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