Date: Wed, 13 Jun 2007 16:17

From: Monica Chowdry

Subject: Tax and damages

Damages are an interesting, and surprisingly complex, area in tax law (I speak only for the UK in terms of actual practice).

Different types of damages are treated differently. In terms of personal injury damages, for example, legislation specifically excludes these from being taxable (most of you will be aware of this principle already - interestingly this exemption is in the same section as lottery and gambling winnings!) However, where compensatory damages are awarded which represent a loss of profits, tax must be paid on them because the profits themselves would have been taxable.

Some problems arise where compensatory damages are awarded in relation to capital assets (e.g. negligent solicitor causes a loss on the sale of property and damages are awarded to reflect this loss) - generally such damages will be taxable under the strict letter of the legislation, but some relief is offered by extra-statutory concession.

Turning to your actual question, whether or not punitive damages should be taxed, this is not something I have come across before (probably because the award is so rare in this country). However, from first principles, the only way to tax this would be as a capital sum (in that the sum clearly does not represent income). To tax a capital sum in the UK, you need to have disposed of something - whilst you might have disposed of your right to sue, this is in exchange for any compensatory damages that you receive. I think it is difficult to find any asset disposed of which could give rise to the charge. One could try to tax it in the same manner as the solicitor/negligent sale example as above, but I think that is unlikely to work and in any case, the extra-statutory concession would exempt any tax. In terms of policy, if we consider punitive damages to be a windfall, then we should treat the damages as similar to lottery or gambling winnings and therefore they would be exempt.

Gain based awards are interesting also. In the example you give, however, I think tax law would see this as similar to the situation above where compensatory damages are awarded for loss of profits.

----------------------
Monica Chowdry
Lecturer
School of Law
King's College London
Strand
London WC2R 2LS
Direct Line: 020 7848 1110 

-----Original Message-----
From: Lionel Smith
Sent: 13 June 2007 15:41
To: ODG
Subject: ODG: FW: Tax and damages

As a side note on punitive damages, I thought I would throw out a comment that a non-lawyer made to me about punitive damages. After I had explained more or less what they were, he immediately said, 'so do you pay income tax on those damages?'. I would guess that in most jurisdictions, the wording of the income tax statute would exclude 'damage' awards, but that was probably written with the idea of compensatory damages in mind. As a matter of tax policy, should punitives be taxable?

And what about gain-based awards? In the Kentucky Caves case, if the defendant had paid tax on cave entrance fee profits, presumably up to some limit of time he could amend his tax returns when he ended up liable to hand over a share of the profits to the plaintiff, to get the tax back. It seems to me that it is hard to see why that money should not be taxable in the hands of the plaintiff.

<<<< Previous Message  ~  Index  ~  Next Message >>>>>