In the recent case of Julian Martin v HMRC, the Upper-Tier Tribunal found that an employee re-paying a signing bonus should receive tax relief because the repayment amounted to ‘negative pay’ for the employee.
Interestingly, the courts noted that ‘negative taxable earnings’ was ‘extraordinarily undefined’ by the legislation and there was no HMRC guidance published on its meaning. The decision has provided an opportunity for HMRC to clarify the uncertain tax treatment of clawbacks and has stated that it will provide guidance on this unusual situation.
Facts
- Mr Martin agreed to enter into an employment contract under which he received a signing bonus of £250,000 with the provision that he would serve the company for at least 5 years. There was an obligation to make repayment in certain cases of termination of employment.
- The bonus was subject to income tax and NICs through PAYE, resulting in a net sum of £147,500. His 2005/06 tax return showed that the sum was seen as taxable remuneration.
- In 2006, Mr Martin gave early notice of his intended resignation, and became liable to repay £162,500 to the company - which amounted to more than the net amount he originally received
- Therefore, Mr Martin was in a negative taxable earnings situation, where he was worse off due to the amount of repayment, and tax he had to pay than if he had not received the signing bonus at all
The Case
Mr Martin ran three alternative arguments as to why he was entitled to relief:
- The signing bonus was in reality a loan
- The signing bonus had only been taxed in full payment due to error or mistake
- The amount of repayment constituted negative taxable earnings, therefore Mr Martin is entitled to tax relief
1. Loan
The First-Tier Tribunal rejected the first point of argument that the signing bonus was in reality a loan, as this was not supported by the facts of the case. Mr Martin did not appeal this decision and it was not discussed further at the Upper Tier Tribunal.
2. Taxed in full amount due to error or mistake
The First-Tier Tribunal held that the signing bonus was not taxed due to error and mistake, and the fact that Mr Martin entered into a contract which stated that he may have to repay a specified sum did not affect the character of the initial payment as earnings. Therefore, his tax returns were correct and he was liable to pay tax on the bonus as part of his taxable earnings.
Mr Martin appealed this point, and argued that while the signing bonus constituted earnings at the time when it was paid, at the moment he handed in his notice the bonus ceased to be earnings. His tax return, although correct when completed, contained an error which he was entitled to correct. The signing bonus was to be seen as accruing over the 5 year period in which he agreed not to terminate the employment contract.
He argued that when he commenced his employment, his entitlement to the signing bonus was contingent upon working for the company for five years. In effect, for each month he worked for the company, he could keep 1/60th of the bonus, which would then be classed as earnings. Therefore, when became obliged to repay a proportion of the bonus, that proportion was never earned.
The Upper-Tier Tribunal rejected his appeal, and concluded that the signing bonus was indeed a one-off payment for entering into the contract, rather than a sum which was earned over 5 years of employment. The bonus did not cease to be earnings when he became obliged to re-pay a proportion of the amount and did not entitle him to amend that return to reflect the payments.
3. Negative earnings
In the First-Tier Tribunal, it was held that relief should be available on the basis that the repayment of the bonus amounted to negative taxable earnings in Mr Martin’s hands. This was the basis of HMRC’s appeal.
Negative taxable earnings was a concept that the tribunals struggled to comprehend, as it is difficult to envisage a situation whereby payments are made by an employee to an employer.
It was noted that there is currently no explanation in the legislation of what it means for taxable earnings to be negative or what items of expenditure by an employee could be brought into account.
The Upper-Tier Tribunal upheld the First-Tier Tribunal’s decision and confirmed that in this case the repayments to the company amounted to negative taxable earnings, therefore Mr Martin was entitled to the relief. As the repayments qualified as negative earnings, the excess could be claimed as an ‘employment loss’ and therefore was relieved against other positive earnings from the same employment arising in that tax year and/or the previous tax year.
See our
December 2014 Tax Update for more recent cases.
