The Upper Tribunal has held that a bonus that an employee had to repay in part to his employer under a clawback provision was negative taxable earnings and could therefore be taken into account for income tax purposes, albeit not for the period in which the bonus payment was made.
Signing bonus repayable if notice given within five years
Mr Martin was paid a sign-on bonus of £250,000 by his employer in consideration for signing a new contract. Income tax was deducted under PAYE at the time the bonus was paid. Under the terms of the contract, Mr Martin was prohibited from giving notice within the first five years of his employment. If he did give notice within that period, the bonus was repayable on a pro rata basis according to how much of the five-year period had elapsed.
Mr Martin did in fact give 12 months' notice less than a year later and consequently repaid a substantial part of the gross bonus to his employer. The clawback was calculated by reference to the date when the notice period expired although the employer permitted Mr Martin to leave employment some months earlier.
Timing of income tax recovery
The Tribunal determined that Mr Martin could not amend his tax return for the year in which he received the bonus in order to show a reduced figure for the bonus. However, the Tribunal recognised that, in principle, a payment from an employee to an employer which arises out of the employment may be treated as "negative earnings". In that case, negative earnings could be set against positive earnings for the tax year in which the repayment is made (or the tax year in which the employment ended if the repayment is made after termination of employment). The effect would be to reduce positive earnings or even to bring them below zero, in which case a claim for employment loss might be possible (although there are limits to the amount of relief available).
On the facts here, the Tribunal held that the repayment of part of Mr Martin's bonus was indeed a payment of negative earnings although it was at pains to point out that its decision turned critically on the interpretation of Mr Martin's contract. Each case, therefore, would need to be decided on its facts and the drafting of the clawback provisions would be crucial. It is not clear, for example, whether the recovery of a bonus on the grounds of misconduct or misstatement of results, possibly at the discretion of the board or remuneration committee, would affect the classification of the repayment as negative earnings.
The amount of income tax that an employee will be able to reclaim will therefore depend upon his tax position in the year of clawback rather than when the bonus is originally paid. This may mean that more tax is paid on the bonus overall than if the clawed back bonus had never been paid, for example, because the employee is subject to a lower rate of tax in the year of clawback. Although this is an issue for employees rather than employers, an employer may nonetheless be reluctant to recover a bonus on a gross basis if this would leave the employee out of pocket. One approach may be to give the employer discretion as to the amount of the bonus which is clawed back, with one of the factors to be taken into account being the possibility of the individual being able to recover the income tax paid.
We understand that HMRC does not intend to appeal the decision in the Martin case and may issue a statement of its policy in respect of the tax position on the clawback of bonuses. This would be welcome if it provides some certainty as to the general position.
Treatment of NICs on a clawback of earnings
An important point to be aware of is that the Martin case only concerned the recovery of income tax. Both the employer and the employee would be liable for NICs in respect of a bonus payment, and there is no statutory provision for the recovery of NICs in a clawback situation. We understand that HMRC may consider treating NICs in the same way as income tax but, again, we need to await any HMRC policy statement in that regard.
Please click on the links below for the other articles in the November 2014 tax newsletter:
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