IPTM5020 - Periodical payments: tax exemption: payments under the original court order or settlement agreement

Main condition for tax exemption

For periodical payments of personal injury damages to be exempt from income tax, they must be made under one of the following arrangements:

  • an order of a UK court made under section 2 of the Damages Act 1996, or
  • an order of a court outside the UK which is similar to a UK order made under section 2 of the Damages Act 1996, or
  • an agreement which settles a claim or action for damages for personal injury or which provides for payments on account of damages pending full settlement, or
  • a Motor Insurers’ Bureau (MIB) undertaking in relation to a claim or action in respect of personal injury.

These requirements are set out in ITTOIA05/S731.

When the settlement provides for periodical payments at the time of settlement, the link to the original settlement is crucial and the tax exemption is only available when the damages are agreed as periodical payments by agreement or order of the court. It does not apply where the injured person or his or her representatives take a lump sum and are then able to independently invest that lump sum as they please, for instance by buying an annuity. Further detail on the treatment of annuities is at IPTM5050.

Court orders and other relevant documentation

For tax treatment purposes, when an officer of HMRC is advised that a claim for periodical payments is exempt and there is any doubt whether the exemption applies, then he or she should obtain a copy of the court order, agreement or other relevant documentation governing the provision of the periodical payments.

In most UK cases there will be a court order even if both sides are agreed on the terms of the settlement. This is because there is a requirement to obtain a consent order from the court in cases where the injured person is a minor or incapacitated which, given the nature of these settlements, is often the case.

An order or agreement may not explicitly refer to an order under section 2 of the Damages Act 1996, particularly if it is from a foreign court. However, it will be clear from the wording of the order or agreement whether it awards, or settles a claim or action for, damages for personal injury which consist wholly or partly of periodical payments.