A recent case has highlighted the tax implications for an employee when a clawback provision in a contractual bonus is operated.

The case has implications for how clawback arrangements are structured. Employers likely to implement a clawback provision should be aware of the outcome of the case and its effect on employees. Employers with clawback provisions already in place should review these to see if they are fit for purpose.

The case concerned a dispute between a taxpayer and HM Revenue & Customs (HMRC) over the taxpayer's income tax liability on a bonus received from his employer. Part of the bonus had to be paid back by the taxpayer, pursuant to provisions in the taxpayer's contract of employment.

The kind of contractual clawback provision exercised in this case is becoming more common in employee bonus and share scheme arrangements. The case is a useful indicator of what the tax effect of such a clawback might be.

Facts of the case

The taxpayer entered into a new employment contract under which he received a signing bonus of £250,000 for committing to work for his employer for at least five years. Tax was paid in full at the time that the £250,000 bonus payment was made.

The employment contract said that if he left his employment before the end of that five year period the taxpayer would have to repay a proportion of the gross amount of the bonus (in accordance with a formula in the contract).

Before the five year period ended, the taxpayer served notice to leave his employment, triggering an obligation on him to repay £162,500 of the signing bonus. In the tax year in which the repayment was made, the taxpayer had taxable employment income of £140,000 (i.e. £22,500 less than the sum that he had had to repay).

The taxpayer applied, through self-assessment, for tax relief in respect of the gross amount that he was required to repay to his employer.

HMRC refused to allow relief. It argued that the correct tax had been paid through PAYE at the time the bonus was paid and that, while the end result would be hard on the taxpayer, obtaining tax relief in these circumstances was not envisaged by Parliament when it enacted the Income Tax (Earnings and Pensions) Act 2003.

So the taxpayer took the case to the First Tier Tribunal, which is the first appellate court above HMRC.


The taxpayer raised three arguments during the hearing:

  • that the bonus was in fact a loan and so he should not have been taxed on the whole amount up front, instead he should have been taxed on tranches of the loan as they were written off by his employer;
  • that the bonus was being earned in increments over the 5 year period, so he should not have been taxed on the whole amount up front, instead he should have been taxed on the increments as they were earned; and
  • that the repayment should be deducted from his taxable employment income in the year of repayment (to reduce his taxable employment income to zero) and the £22,500 excess treated as 'negative taxable earnings' which could be offset against his other (non-employment) income for UK tax purposes.

The tribunal rejected the taxpayer's first two contentions on the basis that the facts did not support them. The tribunal noted that the arrangements could have been structured in this way, had the parties so wished, and the arguments would then have been successful.

Ultimately, the taxpayer's appeal was accepted by the tribunal on the third argument. Therefore, the taxpayer's UK income tax bill for the year in which the repayment occurred was reduced to reflect the economic impact that the repayment had on his employment earnings and other income.


This outcome is a common-sense approach to the legislation allowing the taxpayer to obtain tax relief in relation to the gross amount of the bonus that he had to repay.

National insurance contribution (NIC) relief that may be available in connection with such a repayment were not dealt with in this case. But, the case report notes that HMRC indicated during proceedings that NIC adjustments would be made if the taxpayer was successful.