Out-Law News | 02 Oct 2014 | 9:41 am | 3 min. read
The tribunal found that Julian Martin had "negative general earnings" when he repaid a signing-on bonus in a later tax year, after the full amount received had been taxed in the year of receipt. This meant that Martin was entitled to claim employment loss relief, according to its judgment (45-page / 194KB PDF).
Remuneration expert Graeme Standen of Pinsent Masons, the law firm behind Out-Law.com, said that the decision would make clawback provisions more appealing to those employers that had previously rejected or limited them because of the tax consequences.
"It has long been understood that clawback raises difficult legal and practical issues, including doubt as to whether income tax paid on the original payment could be recovered by the employee after clawback," he said. "This has resulted in employers often requiring only clawback net of income tax, effectively leaving the employer out of pocket for the income tax which neither employer nor employee could get back."
"Employers should review any bonus or other payment clawback provisions they have, and the circumstances in which they are intended to apply, as it will now be easier to claw back gross amounts, ensuring that employers are not left out of pocket by recovering only net amounts," he said.
"Before this decision, gross clawback could seem unduly harsh, making bonuses and long-term incentives less effective as performance or retention mechanisms. The availability of clawback tax relief may also make it less necessary for employers to rely on a complex 'malus' system, which adjusts bonus amounts during deferral periods, to take account of subsequent performance and adjusted views of original performance," said Standen.
Clawback is the mandatory repayment of pay, usually bonuses, when specified circumstances arise after payment. It is increasingly expected to apply to senior executives of publicly-listed companies and senior financial executives by shareholders, politicians and the public. It is also expected or required to apply to the same groups in increasingly robust terms by the rules or codes of national regulators, including the Financial Reporting Council and the banking industry regulator, the Prudential Regulation Authority.
Martin and another individual had been employed by a company, JLT Risk Solutions, which late in 2005 required them to sign new employment contracts with a view to tying them to the company for at least five years. The contract included a £250,000 "signing bonus", with an obligation to repay a time-apportioned proportion of the amount if the employment relationship ended before the five-year period was up.
In November 2005, Martin received his first salary payment as well as the £250,000 bonus. Both were treated as 'emoluments' subject to income tax and employee national insurance contributions (NICs). The effect was that Martin received a net bonus payment of £147,500. In August 2006, Martin gave JLT formal notice of his intended resignation. As a result, he became liable to repay £162,500 of the bonus, which he did. Martin then brought a claim against HM Revenue and Customs (HMRC) for tax relief.
Taxes on employment income, including how the amount charged to tax for a tax year is to be calculated and who is liable for the tax charged, is governed by the 2003 Income Tax (Earnings and Pensions) Act (ITEPA). The dispute centred on whether the signing bonus ceased to be 'earnings' for the purposes of ITEPA when repaid or whether it became 'negative taxable earnings'. HMRC tried to argue that the repayment was liquidated damages for breach of an implied provision that employee notice would not be given before the fifth anniversary of the contract and therefore not earnings at all.
In its judgment, the upper tier tribunal ruled against HMRC although for different reasons than the first tier tribunal. It said that a payment from the employee to the employer or certain third parties would fall within this category if that payment had "the attributes of positive taxable earnings ... with suitable adjustments". The payment would have to arise directly from the employment and not for some other reason, the tribunal judge said. On the circumstances of this case, the repayment of the bonus could be classed as negative taxable earnings and so employment loss relief could apply.
Standen said that although the tribunal judge had been careful to distinguish between the circumstances of this case and other potential payments from employee to employer, the decision provided a useful explanation of a previously unclear section of tax law.
"One point that remains to be considered is the extent to which this decision might be applied to clawback of employment income taxed under different provisions, such as shares and other securities acquired by employees in various ways," he said. "These are taxed as 'specific employment income' and not 'general earnings', as was the case with the bonus payment here.