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Tribunal ruling suggests tax relief likely, but questions remain

The judgment of the Upper Tribunal on the Martin case could pave the way for a fairer tax treatment of bonus clawback arrangements.

September 2014

Brief summary of the facts of the case

In the 2005/06 tax year Mr Martin agreed with his employer to enter into a new employment contract under which he received a “Signing Bonus” of £250,000.  His employment contract required repayment of a proportion of the bonus (calculated on a time basis) if he terminated his employment within five years.  Less than a year later, Mr Martin gave notice of early termination, and duly repaid £162,500 in 2006/07.  HMRC denied any tax relief to Mr Martin for the repayment.

HMRC seems to have accepted that where a clawback is contractual, then any repayment reduces earnings.  However, the argument they pursued was that the repayment in this case was not contractual but was liquidated damages for his breach of the contract.  Disagreeing with HMRC, the Upper Tribunal accepted that the contract contained conflicting terms but considered that it was open to the employer to accept the resignation notice given by Mr Martin as effective and it was in the employer’s interest to do so because it preserved the contractual obligation on Mr Martin to refund the money.  Therefore, the repayment amounted to negative earnings and a repayment of income tax was due.

Deloitte view
Longer periods of deferral, malus and clawback are increasingly prevalent throughout UK Plc, and the UK Corporate Governance Code now includes a provision that companies should have both the ability to be able to recover sums paid and to withhold the payment of any sum. There are a number of issues around introducing clawback and malus which are, as we noted in our news bulletin last week, quite complex and companies need to start planning for this as soon as possible.

From a tax perspective, if HMRC does not appeal the Martin case, employers will feel more confident designing clawback provisions on a gross rather than net basis where employees are able to recover a corresponding amount of income tax they have suffered at source.  However, unless the NIC rules are changed, employers and employees are likely to remain out of pocket in relation to NIC.   

While the case paves the way for a fairer tax treatment of clawbacks, a number of uncertainties remain and there are many complex issued not addressed by the Martin case, including:

  • Mr Martin’s sign on bonus and clawback requirement were both contractual – in the case of discretionary bonuses a contractual requirement for clawback will need to have been established;
  • HMRC may appeal;
  • HM Treasury is currently considering future policy on remuneration practices more generally;
  • The ability to recover NIC remains doubtful since the NIC regulations require an error to have been made at the time of payment – there was no error when Mr Martin’s Signing Bonus was paid
  • Where corporation tax relief has been claimed, a corporation charge is likely to arise on clawback;

How these rules apply in the case of clawed back shares (not relevant in the Martin case), if they apply at all, raises even more complex issues e.g.

    - on what value might relief be claimed if an income tax charge has arisen on a share vesting but the value of the shares has changed when the shares are clawed back;

   - what happens if the value of vested shares is clawed back in cash, i.e. after delivery to and after having been sold by employees;

   - the capital gains tax position is unclear and legislation may need to be amended to avoid anomalies that could arise;

Also, it is not yet clear whether the ruling will be accepted for other tax claims retrospectively or prospectively only – in our view, the case just clarifies existing legislation - nothing has changed and so retrospective claims should be considered, subject to the facts of each case and applicable time limits.

However, the prospect of making negative earnings claims in relation to clawed back amounts will be decided on the facts of each case and will be subject to any future potential appeal, published guidance from HMRC, legislation or policy change.

Please do not hesitate to contact any of the names below if you would like to discuss this in more detail.

Tax Treatment of Bonus Clawback

The judgment of the Upper Tribunal on the Martin case could pave the way for a fairer tax treatment of bonus clawback arrangements.

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