Imagine a situation where your employers have given you a juicy bonus, but have drafted in a clawback provision which states that in certain circumstances you will have to repay some or even the entire bonus. You may be shocked to learn that prior to the recent decision of HMRC v Julian Martin [2014] UKUT 0429 ( ‘Julian Martin’) you would have been liable to repay the gross amount, despite the fact when you received the bonus it would already have been subject to PAYE deductions.
There has been some concern about the lack of Parliamentary action to ensure that effective relief is given for bonus clawbacks, but thankfully the Upper Tribunal has stepped in and confirmed in the Julian Martin case that HMRC will have to reimburse taxpayers who repay their bonus, to avoid individuals having to pay back more than they received in net income. If your bonus clawback arises from breach of contract, you will not however qualify for tax relief.
The Facts
The facts of the Julian Martin case are as follows: Mr Martin joined JLT in 2005 and he received a £250,000 ‘signing bonus’, with the contingency for it to be repaid on a sliding scale if he left within five years. When he departed a year later, he became liable to repay £162,500 of the bonus, which was more than the £147,500 payment he had received net of income.
HMRC argued that tax relief should not apply because the payment amounted to liquidated damages for breach of contract but this argument was swiftly rejected by the Judge and Mr Martin obtained relief on the ground that the £162,500 payment comprised of ‘negative’ taxable earnings. As such it was deductible for the tax year in which he made the repayment and Mr Martin was able to claim employment loss relief.
Employees can breathe a sigh of relief as HMRC have confirmed that they will not be appealing the Upper Tribunals decision to the Court of Appeal.
Problems
One of the problems with this decision is that unless repayment occurs in the same tax year as the bonus payment or the repayment gives rise to negative taxable earnings and the ‘employment loss’ is carried back to the tax year, the employee takes the risk that their income tax rate has changed.
Secondly, National Insurance Contributions (NICs) rules are not the same as income tax rules and without the rules being aligned with the income tax rules, employees and employers will be left out of pocket in relation to their NICs liabilities. No doubt the employee NICs liabilities will be negotiated between the Parties and the outcome dependent on their relative bargaining power.
Benefits
The benefit of this decision is tax relief has been one of the most contentious aspects of bonus clawback provisions, as employers felt uneasy about seeking gross clawbacks as it would make bonuses and long-term incentives less effective as performance or retention mechanisms. This Judgment will therefore remove this obstacle and employers should now review any bonus or other payment clawback provisions to ensure they are received the full gross amount.
Comments
This ruling can be seen as nothing but fair. Until now employees could find themselves in a far worse place than if they had never received the bonus in the first place. It is only right that employees can obtain income tax relief for the repayment. The tribunal highlighted that this decision turned on the facts in the case, but I have no hesitation in stating that employees in similar situations should investigate whether they can recover any income tax on the amounts clawed back.
One thing that is still left unresolved is what will happen to bonuses that are paid in shares or other securities and are subsequently clawed back? No doubt this is something the HMRC are looking into and will be commenting on soon, watch this space!