UK: Bonuses

Last Updated: 25 March 2013
Article by Bob Mecrate-Butcher

Provisions for the clawback of bonuses in line with the FSA Remuneration Code are increasingly common. It also seems clear that the FSA will expect to see that a clawback provision has been utilised where risks have materialised, there have been repudiatory breaches or there has been material poor performance. However, one consequence of including a clawback is the impact on tax already paid. This was considered in a recent case by the first tier tax tribunal.

Tax relief on bonus clawback

In Julian Martin v HMRC a tribunal held that when an employee repaid part of a signing-on bonus under a clawback provision, this constituted negative taxable earnings for the purposes of the income tax legislation.

In addition, where a payment amounted to negative taxable earnings, this should first be offset against other earnings for the relevant tax year (the year in which the repayment is made). The tribunal also decided that to the extent that negative taxable earnings exceeded taxable earnings, the employee should be able to claim relief for a loss in the employment under the relevant legislation but only going back as far as the tax year before the loss making year.

Key Points to take away

  • Employers and employees should be aware that the carrying-back of any employment loss is limited to the tax year before the loss-making year. As this means taxpayers who are required to repay large bonuses may not be able to use all of their employment loss to recover the tax already paid, where a large bonus is being paid to an employee which is subject to clawback provisions, some consideration may want to be given as to how the bonus is structured in the first place (for example, by releasing it in tranches).
  • Additionally where a bonus subject to clawback has already been paid to an employee this may be an issue to be considered when structuring payments under a compromise agreement. For example, it may be preferable if the repayment of the bonus by the employee is set off against payments the employer is liable to make under the Compromise Agreement. The position will need to be examined in a case by case basis and will depend to some extent on the figures involved.
  • This relief is due to become even more restricted from 6 April 2013 when the relief will be capped at the greater of Ł50,000 or 25% of the individual's income (calculated in accordance with specific provisions in legislation to be published).

Bonuses deferred to avoid 50% tax

Following media reports that Goldman Sachs and others have been considering deferring bonus payments so employees can take advantage of the lower additional income tax rate of 45% in April 2013 employers who are considering doing this should be aware of the potential pitfalls. These include:

  • That the deferral of any contractual entitlement must take effect before the bonus amount becomes due and therefore taxable, otherwise liability will arise at 50%.
  • If the bonus is to any extent contractual then the employer will require the employee's agreement to defer payment. If their agreement is not obtained, there is a risk that the original date will apply, again attracting liability at 50%.
  • Employers would be at risk of litigation if they sought an employee's agreement to defer and then dismissed the employee after the original payment date but before the new payment date, thereby removing the employee's entitlement to the bonus.
  • It should not always be assumed that the deferral is beneficial, as this will depend on the marginal rate of tax of the individuals concerned.

In addition, there are particular issues in relation to directors to be considered as bonuses that constitute money earnings and are payable to directors are subject to more restrictive requirements that can effectively accelerate a tax charge.

We have already advised a number of clients on the tax and employment aspects of this issue. If you need specific advice, please contact us.

Other bonus news

Attrill v Dresdner: an appeal against the High Court decision on contractual bonuses was due to be heard in the Court of Appeal on 4 or 5 March 2013. We will keep you updated on this.

In line with the FSA Remuneration Code, various attempts to curb risk-taking are being made via bonus schemes. Barclays is reported to be introducing a new bonus scheme with criteria which relate to its "culture and ethos" aimed at stopping excessive risk-taking while Credit Suisse is reportedly launching a third asset-backed bonus scheme which allows the bank to move away from cash bonuses to bonuses that are aligned with the risk the bankers are taking.

Recent European Securities and Markets Authority guidelines state that deferred parts of bonus awards for risk-taking employees should be paid out over a 3 to 5 year period in line with bank-style pay rules. Firms should also have the power to revisit, or claw back bonuses in situations where employees are guilty of fraud or supplying misleading performance information.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Bob Mecrate-Butcher
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