Nitty-gritty of settlement awards

It has become commonplace to read about employers having to pay large settlement sums awarded by the Employment Relations Authority (ERA) for unjustified actions and dismissals. However, often there is no explanation about how those awards are made up.

There are a number of remedies available to an employee who succeeds with a personal grievance. The primary remedy is reinstatement.

The employer is also entitled to reimbursement of wages or other money lost as a result of the grievance.

This is usually for a minimum of three months’ lost remuneration, but the ERA has discretion to pay a greater sum.

In addition, an employee can claim loss of any benefit, whether or not of a monetary kind, which they might reasonably have been expected to receive if the personal grievance hadn’t arisen.

On top of lost wages and lost benefits is compensation for humiliation, loss of dignity and injury to feelings. This is commonly known as a tax-free payment.

The remedies available can be reduced if the employee has contributed to the situation that gave rise to the personal grievance.

By far the majority of personal grievances are settled by negotiation or at mediation. Generally, they are documented in a record of settlement signed off by a mediator from the Ministry of Business, Innovation and Employment.

This not only records the full and final nature of the settlement, but also means that any breaches of the settlement are immediately enforceable in the ERA.

Because genuine compensatory payments are not taxable, there is a real attraction to employers paying as much settlement monies under this heading as possible and therefore avoiding having to pay tax.

Compensatory settlements are also attractive to employees for the same reason.

But if the settlement includes lost wages and contractual obligations, such as payment of notice periods, then these payments will attract PAYE.

The IRD has issued a public ruling about payments under the Employment Relations Act for humiliation, loss of dignity and injury to feelings.

Where these payments are genuinely made under the Employment Relations Act they are not income and therefore do not attract PAYE.

Out-of-court settlements can similarly include payments for humiliation, loss of dignity and injury to feelings. These are made in return for the employee surrendering their rights under the Employment Relations Act.

The public ruling states that there should be no difference in the tax treatment of payments dependent on whether or not the parties used the Employment Relations Authority or Employment Court.

A payment can be for humiliation, loss of dignity and injury to feelings of the employee whether the authority or court is involved or not.

But the ruling cautions against shams. Shams include excessive allocations for compensation or characterising a payment as being compensation for humiliation when, in reality, it is for lost wages.

The IRD has search powers to access documents for the purposes of collecting any tax or carrying out any function lawfully conferred on the commissioner.

Where the commissioner has some doubt about the amount attributed to compensatory payments, they may ask the parties to an agreement what steps they took to objectively evaluate the amount of the compensatory payment. This is regardless of whether or not the settlement was signed by a mediator under the Employment Relations Act.

The IRD can also inquire whether a personal grievance has been raised; whether the employer acted fairly and reasonably; how the compensatory amount was assessed and whether it is consistent with comparable cases.

The IRD can request supporting documentation, such as copies of personal grievance letters and evidence of how the compensatory amount paid was assessed against comparable cases.

If the IRD forms the view that the payments have not been genuine then there is a very real risk to the employer. This includes a requirement to pay the tax component on the compensatory payment, along with penalties and interest.

If the IRD enforces this, then the employer may need to advise the other party to the settlement that the payment has been assessed by the IRD as taxable. This may create issues for the other party as it can impact their overall tax position.

Eligibility for family support and payment for child support, student loans, et cetera, will be impacted. Imagine having to inform a disgruntled ex-employee not only that the terms of the record of settlement they thought were confidential have become known to the IRD but, worse, that their tax position has been negatively impacted.

The Chief Employment Court Judge has issued guidance on the amount of compensation a successful personal grievant should expect to receive. Low-level damages may range as high as $10,000. Moderate damages span between $10,000 and $40,000 and significant damages justify payments over $40,000.

Employers making compensatory payments would be wise to reference the court’s guidance and to consult with their financial advisers on the potential tax ramifications of making such payments.

Disclaimer: The opinions expressed in this article are those of the writer and do not purport to be specific legal or professional advice. John Farrow is a litigation partner with Dunedin law firm Anderson Lloyd.



I enjoyed reading this opinion. It sets out the entitlements of parties to disputes and how remedies are decided upon and taxed. It also alludes to the fact that the whole grievance process is overseen by the Employment Court, although it assumes that the public at large is aware of the constitution and make up of the Employment Court and how it stands in the line-up of NZ Courts and Justice system.
The other deficiency, although I guess space limitations precludes Farrow covering off every point, is that he does not explain how the Mediation Service, the ERA and the Court go about their decision making process. While they are guided by the statute law there is also over 120 years of case law and precedent that heavily influences how rulings are made. the ERA members, in making a decision do not and cannot act of their own volition, they must follow the law laid down in statute and prior cases. This requirement is not usually well reflected in general press coverage of ERA and employment Court decisions and can result in public perceptions that decisions seem to favour workers who, on the face of the reporting, seem not to deserve public sympathy.
But overall a great article.

This - "public perceptions that decisions seem to favour workers who, on the face of the reporting, seem not to deserve public sympathy" - is based not only on media reporting but on conversations with people who saw the situation, worked alongside the person who received "free money" or the boss whose behaviour was often unreasonable. In the community it becomes known who has a record of (manipulated situations that led to ) richly rewarded dismissals. These are a minority, but apparent uncritical acceptance of their claims for compensation casts doubt over the whole process.

So, what you're saying is that employers, at least some of them are stupid.
The fact is that ERA and court decisions are based on the evidence, given under oath, presented at the hearing. If a decision favours the worker then it is because the evidence, when weighed against the law, falls that way.
If the evidence has been "manipulated" by the worker then at worst you are suggesting perjury and at best that the employer and his lawyer are morons. You ignore the fact that very few employers exercise the right to appeal what they see as incorrect decisions and those that do appeal invariably lose.
The reality is that negative public perceptions is caused by media reporting that focuses on the sensational elements of a case and the ignorance, gossip, innuendo. and to a certain extent, jealousy within the public at large.

Our journalists are your neighbours

We are the South's eyes and ears in crucial council meetings, at court hearings, on the sidelines of sporting events and on the frontline of breaking news.

As our region faces uncharted waters in the wake of a global pandemic, Otago Daily Times continues to bring you local stories that matter.

We employ local journalists and photographers to tell your stories, as other outlets cut local coverage in favour of stories told out of Auckland, Wellington and Christchurch.

You can help us continue to bring you local news you can trust by becoming a supporter.

Become a Supporter