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Martin and tax on remuneration clawbacks

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A significant increase in the use of deferral and clawback in recent years is largely attributable to demands by regulatory bodies and institutional investors to align reward with risk and results. The Upper Tribunal decision in HMRC v Julian Martin [2014] UKUT 0429 provides an opportunity for policy makers to clarify the current uncertain tax treatment.

Income tax

Where an amount qualifies as negative earnings, it can be relieved first against positive earnings from the same employment in the same year. This is confirmed by the Julian Martin decision, although PAYE regulations do not authorise a negative payroll entry and HMRC guidance is awaited.

In addition, where negative earnings exceed positive earnings, the excess can be claimed by employees as an ‘employment loss’ against other income arising in the same tax year as the loss, the previous tax year or both. The claim must be made within a year from the normal self-assessment filing date for the loss-making year, specifying which year’s income to offset the loss against first. This provides a limited opportunity to optimise the employee’s tax position for either year.

Where shares rather than cash are clawed back, the tax treatment depends on whether this amounts to negative earnings or negative specific income. If earnings are negative, the above rules should apply. However, negative specific income cannot be offset against general earnings or other income; and an offset against other positive specific income may only be possible (if at all) against the same type of specific income arising in the same tax year. Negative specific income that is not offset cannot be treated as a loss.

Other taxes and NIC

Unfortunately, NIC is unlikely to be recoverable without legislative change. This is because NIC is normally only recoverable where an error was made at the time of payment, which is unlikely to be the case in most clawback cases.

For CGT purposes, the overall effect of a share clawback might be to give rise to an income tax loss, offset by a CGT gain, if a clawback is treated as a market value transaction and if the base cost of shares acquired has to be recalculated following a clawback.

Where a share award initially qualifies for corporation tax relief, it is likely that its claw back would give rise to a CT charge and vice versa. Changes in share value between award and clawback may need to be considered.

Where this leaves us

The Julian Martin decision should encourage employers to structure future clawbacks on a gross, rather than net, basis where employees are able to recover the associated income tax. Employers, however, will need PAYE advice. Employers and employees should check whether a repayment under the overpayment relief rules is available for contractual clawbacks since 6 April 2010.

It is hoped that new guidance from HMRC (assuming it chooses not to appeal) will be provided and possibly the legislation will be changed to better support the commercial requirements of modern UK PLC.