Many employers have, until now, rejected or limited clawback provisions applying to employees’ bonus and incentive arrangements, due to the uncertain and adverse tax consequences. A recently published Upper Tier Tax Tribunal judgment, HM Revenue & Customs v Martin allowed tax relief to an employee whose signing-on bonus was subject to clawback provisions, meaning that clawback arrangements could now become more appealing to employers.
Clawback is the mandatory repayment of pay, usually bonuses, when specified circumstances, for example, leaving employment within a set period of time, 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.
Clawback arrangements have always raised difficulties from both a legal and practical perspective. The British Bankers’ Association argued earlier this year that the Bank of England’s proposals to impose the “world’s toughest rules” for clawing back bonuses from bankers could be unenforceable from an employment law perspective, noting that “the actual ability to enforce clawback will be dependent on the decision of a court to enforce clawback clauses in employment contracts”.
Who ends up out of pocket?
One of the main uncertainties in relation to clawback has been the question of whether the income tax paid on the original bonus could be recovered by the employee (or the employer) after the clawback. As a result, many employers insisted only on a “net clawback”, namely a clawback of the amount of the bonus which the employee actually received in his hands. These arrangements left the employer out of pocket for the amount of income tax which neither employee nor employer could recover from HMRC.
“Gross clawback” provisions have been seen as unduly harsh for employees, and arguably make bonus arrangements and long-term incentives less effective as performance or retention mechanisms.
HMRC v Martin – shedding some light
Julian Martin was employed by JLT Risk Solutions. JLT required Martin to sign a new employment contract in November 2005 with a view to tying him to the company for at least five years. Under the contract, Martin was paid a “signing bonus” of £250,000, repayable on a time-apportioned basis if Martin’s employment terminated within five years.
The bonus payment was treated as an “emolument” under income tax legislation, and was accordingly subject to income tax and employee’s national insurance contributions. The net bonus, after tax and employee’s NICs, was £147,500. In August 2006, Martin gave formal notice of resignation to JLT, which resulted in him being liable to repay £162,500 of the signing bonus.
Martin repaid £162,500 to JLT and brought an income tax relief claim against HMRC in respect of that amount. Tax on employment income is governed by the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”). The dispute concerned whether the signing bonus ceased to be “earnings” for the purposes of ITEPA when it was repaid, or whether the amount repaid became “negative taxable earnings”. HMRC tried to argue that the repayment was liquidated damages for breach of an implied provision that notice would not be given by the employee before the fifth anniversary of the new employment contract. This would have meant that the repayment of the bonus was not earnings at all and that no income tax claim could be made.
The tribunal ruled against HMRC, stating that a repayment by the employee to JLT would be treated as earnings if the payment had “the attributes of positive taxable earnings... with suitable adjustments”. This means that the payment would have to arise directly from the employment and not for another reason. The tribunal held that the repaid bonus could be classed as negative taxable earnings and therefore employment loss relief could apply.
Is relief available for all clawback?
The tribunal judge was very careful to distinguish the circumstances of Martin, in particular his interpretation of the contract, from other potential payments from employee to employer. However, the decision provides a very useful explanation of a previously unclear section of tax law.
The decision also naturally leads to as yet unanswered questions as to how it might apply to clawback provisions relating to other sources of employment income, such as shares acquired by employees, which are taxed under different provisions of ITEPA.
In this issue
- Respect revived
- Adoption: when should contact continue?
- Family values
- Designs on IP law
- Section 29 claims, time bar and service
- Sharing the rewards
- Reading for pleasure
- Opinion: Lauren Wood
- Book reviews
- President's column
- Making the big changeover
- People on the move
- Another leap forward
- LBTT: aligning payment and registration
- The (legal) people have spoken
- Powers of attorney: another angle
- Greatness begins with a pin badge
- Jackson: has it delivered?
- The test for causing alarm
- When do licensed premises "cease to be used"?
- Empowering communities
- Has clawback lost its tax bite?
- Scottish Solicitors Discipline Tribunal
- Property Law Committee Update
- Call it a comeback
- Refereeing the referendum
- Law reform roundup
- From the Brussels office
- What's next for SYLA?
- Mediation first
- When life begins at 60
- With growth there is risk? (2)
- Ask Ash
- Sustainable future: new ideas for the training contract
- Mentoring - why?
- Lender Exchange: what's it about?
- A bar removed