Many organisations impose clawback provisions on their executives’ bonuses. This is not just a feature of the financial services industry; many employers see the advantages of linking payment to long-term performance.
The tax position of such arrangements is complicated by the commercial imperative to pay the bonus upfront, and any repayment occurs only at a later date (clawback). Such bonuses are taxed on receipt, and the difficulty is obtaining tax relief for the repayment.
The rules governing deductibility of amounts paid by employees are restrictive, particularly if the expense exceeds the salary from the employment and is a loss.
This was the case for Julian Martin, whose bonus arrangements have been the subject of two tax tribunal decisions (HMRC v Martin).
Martin was paid a £250,000 bonus (£147,500, after pay-as-you-earn (PAYE) and national insurance deductions) not to resign for at least five years. If he did so, he had to repay a pro-rata amount of that bonus.
He resigned after a year and had to repay £162,500 (£15,000 more than he received) to his employer. Both the first-tier and upper tribunals allowed his appeal for tax relief for that repayment.
Although Martin’s appeal succeeded, there are reasons to be cautious.
Despite an ambitious argument by Martin, he was not able to reclaim the PAYE deducted from the bonus. Relief is available only as a deduction against income for the tax year when the repayment is made.
If the employee does not have sufficient earnings from that employment in the same tax year, effective relief might not be available for all the repayment. Even if there is other income, since 2013 there is a limit (£50,000 or 25% of income) on the amount that can be relieved against other income.
The availability of even that limited relief depended on the precise terms of the contract. In particular, it was important that the repayment was not liquidated damages for breach of contract.
The difficulties of obtaining effective relief are particularly acute for repayments made after the employment has ended, particularly if made in the following tax year, and the position is especially complex for clawback of shares or other non-cash assets.
There are other ways to structure bonuses which defer tax until the possibility of clawback has passed, but these typically involve using a loan. This has its own issues, including the annual benefit-in-kind charge for interest-free loans.
Andrew Roycroft is a senior associate at law firm Norton Rose Fulbright