In this case, the First Tier Tribunal (FTT) was asked to consider whether the liability of an employee under his employment contract to refund a proportion of a taxable signing bonus when the employee gave notice to resign prior to the end of the period for which the employee had committed to remain an employee was “negative Taxable Earnings”

Background

The taxpayer, Mr Julian Martin, entered into a new employment contract with a company, known as JLT. Under clause 4.4 of the employment contract, he was entitled to receive a signing bonus of £250,000 for committing to work for JLT for at least five years. The contract also provided that he would be potentially liable to repay a fraction of that bonus under a specified formula if he gave early notice to terminate his employment in breach of the 5-year commitment.

In November 2005, JLT paid the taxpayer his first salary payment and the signing bonus. Both were treated as emoluments and paid under deduction of PAYE and employee's National Insurance contributions.

In October 2006, the taxpayer gave formal notice of his intended resignation, which was accepted by JLT. Under the formula in his contract of employment, Mr Martin then had to repay £162,500 of the £250,000 signing bonus, retaining the remainder.

Mr Martin then sought to bring an error or mistake claim for the tax year 2005–06 claiming that the full signing bonus had initially been taxed in that year and that taxation had anticipated the receipt of income that had not in fact been earned in that year and which later emerged never to have been earned.

HMRC rejected the claim and denied any relief for the fact that much of the taxed bonus had been repaid. The taxpayer submitted that an error had been made when paying and reporting in his tax return the total amount of the signing bonus in the relevant period.

He stated that only a small portion of the bonus had been earned in that period further arguing that the repayment of £162,500 in 2006–07 was a payment of negative earnings by the taxpayer. Finally, he argued that the payment of the bonus was, in substance, a loan.

The taxpayer appealed against HMRC's decision that he was properly taxed on the whole of the signing bonus and was not entitled to loss relief on the element of the bonus that had been refunded.

The FTT was therefore asked to examine whether the taxpayer was entitled to the loss relief under the Income Tax Act 2007 (“ITA”) 2007, s. 128 on ?the element of the signing bonus he had refunded to JLT.

Decision

The Tribunal decided that a signing bonus received by the taxpayer for his five-year commitment to remain in employment with JLT had been properly included amongst his net taxable earnings for the relevant year it had been received.

That was despite the taxpayer's subsequent repayment of a fraction of the bonus for his failure to comply with his commitment. The signing bonus plainly fell within the definition of emoluments as the receipts basis took precedence over any form of earnings notion.

The Tribunal also decided that the signing bonus was not a loan. Although there might have been circumstances in which some amounts of the bonus would have to be paid back, the taxpayer was not a debtor in respect of the entire residue element of the signing bonus.

However, the Tribunal decided that the repayment of the residual element of the bonus was a payment of negative taxable earnings (‘TE’). The obligation to repay was contained in the very employment contract of the taxpayer and the very subclause under which the signing bonus had been paid.

The notion of negative TE could reverse the way in which the receipts basis took precedence over a normal earnings basis.

The Tribunal held that the taxpayer received a signing bonus of £250,000 for committing to remain in employment for a five-year period. That was always subject to the liability in the same contract to repay to the employer the ‘residual element’ of the signing bonus if he terminated his employment prior to the end of the five-year period.

The subclause referred to even contemplated the set-off of other salary payments owed to the employee against amounts of signing bonus liable to be refunded. The liability to refund the payment was designed to induce the taxpayer to satisfy his commitment, and the liability to repay resulted from the taxpayer's failure to honour the commitment.

Accordingly, Mr Martin had to repay the relevant proportion of salary; he had to reverse the salary payment. As that obligation was all contained in the very employment contract and the very subclause under which the signing bonus had been paid, that was an obvious example of ‘negative TE’.

Whilst the FTT believed there was some merit and reality to the taxpayer's submission that he only earned the signing bonus on a period-by-period basis and provided he remained an employee, the reason this contention failed was because the signing bonus was clearly an emolument.

However, where the notion of negative TE could reverse the way in which the receipts basis took precedence over a normal earnings basis (if and only if the earnings were ultimately not earned) that result did not breach any principle. It only gave relief for something that, in retrospect, was not earned, and the liability to make the repayment arose directly under the employment contract.

Thus, the taxpayer's second contention succeeded, such that the net taxable earnings from the relevant employment in the period 2006–07 were reduced to nil. The excess ‘negative TE ’, i.e. roughly the £22,500, should have qualified for relief under the loss relief provisions in ITA 2007.

The full text of the case is available at http://www.financeandtaxtribunals.gov.uk/judgmentfiles/j6943/TC02460.pdf