HMRC guidance on bonus clawback arrangements

HMRC has released guidance clarifying its views on the treatment of the clawback of bonuses and other payments made to employees. The guidance confirms that repayments of bonuses will generally trigger “negative earnings” for an employee to be set against positive earnings or to claim repayment of PAYE deducted and loss relief where there is an excess. With the use of such arrangements increasingly commonplace, confirmation of the tax treatment of repayments is very welcome.

Background

In 2014, the Upper Tribunal in Martin v HMRC held that a repayment by an employee of part of a signing on bonus constituted negative taxable earnings for tax purposes such that the amount of the repayment could be set against taxable earnings in the year of the repayment and any excess allowed as loss relief. See the item, “Employee entitled to tax relief for "negative taxable earnings" on bonus clawback”.

The question of the tax treatment of a bonus clawback or a similar repayment has since become increasingly important given the use of such arrangements, especially by banks and other regulated businesses. Indeed, such arrangements are a necessary feature of certain incentive plans for financial services firms and increasingly expected in other sectors.

New guidance

On 22 December 2016, HMRC released additional guidance for the Employment Income Manual containing HMRC’s understanding of the decision in Martin and guidance on the application of that decision to other cases.

In particular, the guidance explains that just as the mere existence of an employment relationship is not enough for every payment from an employer to an employee to be taxable earnings, equally “not every payment made by an employee to an employer will constitute negative earnings”. The question turns on the reason for which a payment is made: does the payment arise directly out of the employment or is there some other reason?

Therefore, the existence of negative earnings depends on there being a payment made by an employee to another person (most likely to be the employer but there may be circumstances in which a payment to a third party might qualify) that the employee makes for a reason that directly relates to the employment.

The new guidance contains a number of examples at EIM00842 to EIM00845 dealing with bonus clawback arrangements and the correct procedure for dealing with negative earnings in a number of circumstances. These examples deal with the scenario where a person is paid a bonus under conditional arrangements where part of that bonus must be contractually repaid where the employer gives notice of termination of the employment in the following two years and confirm that a repayment will give rise to negative earnings for the employee. The guidance makes it clear that negative earnings should first be set against positive earnings. To the extent there is any excess, it can be recovered to the extent there is overpaid PAYE and otherwise loss relief will be available under ITA 2007 s.128.

Period that negative earnings are for?

General earnings are “for” the period in which they are paid, and the same will normally be true for negative earnings. However, where earnings are paid post-termination, there are specific provisions which provide that earnings are for the last year in which the employment was held (ITEPA 2003 s.17). Although there is no equivalent provision for negative earnings, HMRC accept the decision in HMRC v Martin, that where there is a payment by the employee to the employer made after the employment has terminated, the amount may be taken into account in calculating taxable earnings for the tax year in which the employment ended.

National insurance

It should be noted that there is no equivalent relief in respect of National Insurance paid on the earnings repaid.

Comment

HMRC’s guidance and clarification of the implications of repayments of salary under clawback arrangements is welcome given the increasing use of such arrangements. In particular, since HMRC now clearly accept that an employee will be entitled to recover overpaid tax, employers can now more equitably seek to recover repayments on a gross basis. However, there may still be cases where an employee may suffer loss, since a loss from negative earnings cannot be carried forward and must be used in the loss making year or the previous year. Equally, negative earnings may not be set directly against future income where an employee leaves employment to become an LLP member.