The pressure for companies and firms to claw back earnings paid to executives under various incentive plans has been steadily growing over the last couple of years. There was the clarification in the ABI guidelines on directors’ remuneration on which we reported last November, to PIRC’s two penn’orth on the topic in March, the Bank of England’s mandatory claw-back of bankers’ bonuses from 1 January 2015 and most recently the FRC’s changes to the UK Corporate Governance Code to promote claw-back on share incentive pay-outs from something to which “consideration should be given” to a requirement.
All very clear, but what about the income tax that the banker/executive/director will have paid on the earnings that are clawed back? The Office of Tax Simplification mentioned in its interim report on its review of unapproved share schemes that “employment losses relief and a clawback on vested options” was one of the issues that consultation participants identified as an area of confusion and difficulty, but nothing more seems to have emerged.
The first-tier tribunal case of HMRC v Martin which we covered in February 2013 established the notion of “negative earnings”, the idea being that the taxpayer could reclaim the tax paid on such payments. As a quick reminder, Mr Martin was paid a signing-up bonus when he joined the company, some of which he had to forfeit if he left within 5 years. He did leave, and sought to reclaim the tax he had paid on the forfeited part of the bonus.
The judgment on HMRC’s appeal to the Upper Tribunal has recently been published. HMRC lost again, but not on the basis that the repayment was “negative earnings”. The judge did “not consider that this approach is one that should be adopted in future”. Instead, his reasoning was based on the wording of the relevant contract and the existing legislative provisions relating to earnings.
The repayment required from Mr Martin in this case was clearly set out in his employment contract, which envisaged that he might leave during the first five years after starting the job and described how much of his signing bonus he would have to repay if that happened. There was no room for any argument about whether and to what extent the employee was at fault or what the quantum of damages should be. As the judge says in his summing-up: “my … decision turns critically on an interpretation of the contract. It does not, and is not intended, to give any particular guidance about the application of that approach to different facts”.
So we shouldn’t get too carried away here. There is a distinction to be made from the usual situation where claw-back is used, where there is usually some element of mistake (for example, a mis-statement in the accounts on which the decision as to whether an incentive performance target had been reached was made) or fault or neglect on the part of the recipient. The contract in this case required a part of earnings to be repaid to the employer if a certain event occurred, the proportion to be repaid being set out in a formula. There was no mistake, no breach of contract, no fault.
It seems therefore that the principle of “negative earnings” for clawed-back payments is still up for grabs. HMRC yet has the opportunity to make a policy decision to deal with reclaiming tax on such payments without the Government having to resort to legislation