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Tax treatment of payments for hurt and humiliation

Over the last few years, the tax treatment of payments for hurt and humiliation has become an area of focus for the IRD, with many public sector entities receiving amended PAYE assessments in relation to these payments.

Under section 123 of the Employment Relations Act 2000, where the Employment Relations Authority or the Employment Court determines that an employee has a personal grievance it may provide for a compensation payment for humiliation, loss of dignity, or injury to feelings.

A personal grievance is defined as a grievance in relation to unjustified dismissal, discrimination, sexual harassment, racial harassment, duress associated with union membership, or an unjustified action by the employer that results in the employee being disadvantaged. The test for unjustified dismissal and unjustified action is based on what a fair and reasonable employer would have done in all of the circumstances.

Public Ruling BR Pub 06/05 states that payments that are genuinely and entirely for compensation for humiliation, loss of dignity, or injury to feelings under section 123 are non-taxable. This ruling applies regardless of whether the compensation is determined by the Courts or in an out-of-court settlement.

However, payments for lost income, redundancy entitlements, or exit inducements are taxable and subject to PAYE. Simply classifying the payment as hurt and humiliation in the settlement agreement signed by the mediator does not make the payment non-taxable.

In an IRD review or investigation, the employer would need to be able to show that the employee had a genuine personal grievance (as defined), and that the amount paid was reasonable based on the hurt and humiliation suffered by the employee. It should be noted that most of the amounts awarded by the Courts for hurt and humiliation are under $10,000, and only a small percentage are over $15,000.

In general, it would be very difficult to convince the IRD that any payments over $25,000 were not at least partially taxable. Tax liabilities may also exist in relation to much smaller payments. In cases where there is no evidence of a genuine personal grievance, the IRD could consider the entire payment to be taxable.

This document is intended only as a general guide, and should not be used or relied upon as a substitute for specific professional advice. No liability is accepted for loss or damage incurred by persons who rely on this document.

Page created: 23 June 2017