UK: Bonuses - the Hidden Pitfalls

Last Updated: 20 September 2006
Article by Christopher Booth
Bonuses - the Hidden Pitfalls

Employers commonly believe that they can forgo payment of a bonus by terminating the employment relationship before the payment due date, particularly where the employment contract makes payment conditional upon the employee remaining in service and not being under notice at that date. A recent High Court decision (in the case of Takacs v Barclays Services Jersey Limited) suggests that employees may be able to challenge a failure to pay bonuses in such circumstances.

Mr Takacs was employed as a trader whose contract entitled him to a minimum bonus award in the first two years of his employment, as well as an additional award for each of the two years if he achieved certain sales targets. He did not achieve the sales targets in either year and was dismissed.

Mr Takacs brought a High Court action alleging that:

  • an ‘anti-avoidance’ term was implied into his contract which prevented the employer from firing him in order to avoid its obligations to make the additional bonus awards
  • the employer had breached the implied term of trust and confidence by recruiting other specialists who took over the trade he was negotiating, and
  • there was an implied term in his contract that the employer would co-operate with him in the achievement of the sales targets, something which he argued it had failed to do.

In response to an application by the employer to strike out Mr Takacs' claims, the High Court concluded that there was a real prospect of Mr Takacs successfully arguing his case based on breach of these implied terms.

Although this case is only decided at an interlocutory level and will need to be considered in more detail at full trial, it suggests that the courts may be increasingly willing to place limitations on the employer's express powers of termination. In this case, the High Court felt that the implied ‘anti-avoidance’ term could co-exist with the express powers of termination. If such an argument is to succeed, it will of course be crucial that the employee is able to show that the motive for dismissal is to deprive him of his contractual rights.

Challenge to Revenue's Tax Treatment of "Auto" PILONs

The current approach of HM Revenue and Customs (the Revenue) to payments made in lieu of notice (PILONs) on termination of employment is that such PILONs are taxable in full (and not subject to the £30,000 termination exemption) where:

  • it is a term of the contract that such payments will be made (either expressly or impliedly by virtue of custom and practice) or can be made at the employer's discretion (and the discretion to do so is exercised);
  • the contract is silent, but the employer makes such payments as an "automatic response" to a termination, despite the fact that there is no express or implied right to such PILONs (Auto PILONs).

In the case of SCA Packaging Ltd v HM Revenue and Customs, a Special Commissioner had to consider the tax treatment of PILONs made to several groups of employees. The facts and legal issues raised in the case were complex, but it was in relation to one specific group of employees - those whom the Special Commissioner found had no express or implied right to PILONs - that the Commissioner made his most interesting finding. He found that PILONs made to this group of employees were not taxable in full (and could benefit from the £30,000 exemption) since the payment of PILONs to these employees was not a contractual entitlement. Although there had been previous instances of paying PILONs to employees in this category, this was insufficient to make such payments contractual by virtue of custom and practice since they had not been brought to the attention of the employees and there was no evidence that they had been made without exception for a substantial period. This is in contrast to the Revenue's stated view that PILONS may be taxable even if they are not contractual - all that is required is that payment is made as an automatic response to a termination.

This decision should provide some support to employers who argue that PILONs should benefit from the £30,000 exemption where there is no express or implied contractual right to such payments. It should be noted, however, that the Revenue is appealing this case, and has not altered its approach to dealing with Auto PILONs. Consequently it will always be wise to seek professional advice and if necessary obtain advance clearance from the Revenue before making a decision not to tax PILONs in full.

Do You Need To Know…?

Constructive Dismissal

In order to prove constructive dismissal, an employee has to show, amongst other things, that they did not delay too long in resigning in response to the employer's breach and therefore did not ‘affirm’ the contract. In Quigley v University of St Andrews, the claimant waited two months before resigning, claiming that it took him this length of time to consult a solicitor. In what is believed to be the first case which considers the obtaining of legal advice as the reason for the delay, the EAT rejected the claimant's arguments that an employee could not have ‘affirmed’ the contract without having knowledge of the breach and his legal rights arising from it. The EAT's view was that it is necessary to assess all the evidence in considering whether an employee has ‘affirmed’ the contract, and in any event the EAT felt that all employees are aware that they can leave a job if dissatisfied with it - they do not need a solicitor to tell them this.

Double Recovery of Tax

The case of Demibourne Ltd v HM Revenue & Customs suggests that the Revenue may charge an employer PAYE and NI where an employee has been treated as selfemployed by the employer, without giving the employer credit for the tax and NI already paid by the individual. The case involved an individual who had paid tax under selfassessment over a 10 year period on the basis that he was a self-employed contractor, but who was subsequently held to be an employee. In a change to previous practice, the Revenue concluded that in such situations, PAYE which should have been deducted should be recovered from the employer company, with no credit for tax previously paid by the employee. This does not prevent the employee from claiming a refund for tax paid under self-assessment based on error or mistake, but, in the case in question, it was too late for the employee to do so. This new approach has led to increased complexity for employers seeking PAYE settlements and emphasises the need for employers to carry out a careful assessment of the employment status of any contractors whom they engage.

Age Discrimination Questionnaire

The DTI has published the official age discrimination questionnaire which employees can send to their employers to assess whether they have been the subject of age discrimination. The questionnaire is available at http://www.dti.gov.uk/files/file32724.pdf.

Cases referred to in this update:

Takacs v Barclays Services Jersey Limited, case no 05X03074, 13 July 2006; SCA Packaging Limited v Revenue and Customs [2006] UKSPC SPC00541 (23 May 2006); Quigley v University of St Andrews UKEATS/0025/05/RN; Demibourne Ltd v HM Revenue & Customs [2005] UKSPC SPC00486 (23 June 2005).

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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