Employees who have to repay income may be able to claim tax relief for “negative earnings”

An employee who had to repay part of a signing-on bonus to his employer has successfully challenged HMRC’s refusal to give him tax relief for the payment. It may seem obvious that a person who is taxed on receiving salary or bonus should be entitled to tax relief if they have to pay it back but that’s not the way that HMRC saw things. The taxpayer challenged the official view and has won his case in the tax First Tier Tribunal.

When Julian Martin started his new job he received a signing bonus which he would have to wholly or partly repay if he resigned within the following five years. The bonus was taxed under PAYE and national insurance contributions were also deducted. When he resigned he had to repay part of the gross bonus, so he claimed to deduct that repayment from his earnings under section 11 of the Income Tax (Earnings and Pensions) Act 2003 which provides for relief when an employee’s net earnings are a negative amount. HMRC refused his claim for relief on the grounds that the repayment to his former employer could not be “negative earnings”.

The Tribunal rejected HMRC’s argument and ruled that earnings generally can be either positive or negative and in this case the repayment was ‘negative earnings’.  Positive and negative taxable earnings from any employment need to be aggregated to arrive at a total which may be positive or negative and may create a loss relievable under s 128 ITA 2007.

Employees’ repayment claims

First Tier Tribunal cases do not set precedents and HMRC have indicated that they will appeal, so it is not certain that the favourable ruling will stand but the case opens the way for employees who have to repay their employers to reclaim tax, and possibly claim loss relief against other income and chargeable gains.

Structuring contracts to avoid tax and NIC problems

The problems faced by Mr. Martin might have been avoided if he and his employer had changed the way his signing-on bonus was provided. An employment contract providing a loan arrangement, to be offset against staged bonuses would have avoided the problem.

This could be especially important for the employer who had to pay secondary NICs on the bonus because the NIC rules are not written in the same way as those for income tax. HMRC indicated that if they lost the case they would make adjustments to Mr. Martin’s NIC liability but whether they would accept any corresponding adjustment to the employer’s NIC is not clear. With employer’s NIC currently at 13.8% this is a potentially serious issue.

Whatever the result of HMRC’s planned appeal, this case highlights the benefits of proactive planning when structuring employee contracts. A bonus or salary is subject to PAYE and NIC immediately whereas a loan, although taxable as a benefit in kind, should not usually be taxable in full. PAYE and NIC would be charged on the amounts written off or earnings applied in repaying the loan as and when those write-offs or payments were made.