Beware the tax implications of waiving remuneration

In the current Coronavirus crisis, we understand that a lot of senior employees and directors are trying to do the ‘right thing’ and while a change to the rules on waivers of remuneration might be appropriate, in the meantime, you need to be aware how the existing rules apply.

HMRC’s view of the legislation in Sections 15(2) and 18 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) can be found in their Employment Income Manual at EIM42700 onward (Waivers of remuneration and salary sacrifice: contents) (see https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim42700).

A waiver of remuneration happens when an employee gives up rights to remuneration and gets nothing in return and the effect of a waiver for income tax purposes depends on its timing.

If the remuneration waived is given up before it is treated as received for tax purposes, then the remuneration given up will not be taxable earnings. But if the remuneration waived is given up after it is treated as received for tax purposes then the employee remains taxable on the remuneration given up. In effect, it is not possible to waive entitlement to remuneration already earned without still being liable for tax under PAYE on the waived earnings.

In EIM42720 HMRC provide an example of a waiver of salary and its income tax effects:

“A senior employee, who is not a director, is entitled to a salary of £60,000 a year. This is earned on a day to day basis. The employee is entitled to payment of 1/12th of the annual salary on the final day of each month.

The employer is in severe financial difficulties and does not make any payment of the January 2003 salary. To help the employer, on 8 February 2003 the employer and employee make a revised agreement. The agreement is that the employee will not be entitled to any salary for the period 1 January 2003 to 31 March 2003.

For the tax year 2002/03 the employee is liable to tax on employment income of the salary of £50,000. This is made up of £45,000 (9 x £5,000) paid to 31 December 2002 and the £5,000 that the employee became entitled to payment of on 31 January 2003.

The agreement made on 8 February 2003 does not exclude the unpaid January 2003 salary from money earnings as the agreement was made after the January salary was treated as received for employment income purposes. But the agreement does prevent any employment income tax liability arising on the February and March salary given up.”

And at EIM42725 there is an example of a waiver of a bonus:

“A senior employee, who is not a director, is contractually entitled to a bonus each year. The amount of the bonus is based on the profits of the employing company.

The company’s year-end is 31 January. Accounts for the year ended 31 January 2003 are finalised on 31 July 2003, enabling the amount of the bonus to be calculated. The employee is not entitled to payment of the bonus until 31 October 2003. The employee is informed on 31 August 2003 that the bonus will be £10,000.

The letter informing the employee of the bonus asks the employee to give up her rights to the bonus as the company is now in a difficult financial position. The employee agrees to do this in a letter sent to the company on 30 September 2003.

The employee is not liable to tax on the bonus as employment income because it was given up, on 30 September 2003, before it would have been treated as money earnings for employment income purposes, on 31 October 2003.

If the bonus had been given up after 31 October 2003 the employee would have been liable to tax on the £10,000 as it would have been given up after it was treated as money earnings for employment income purposes.”

In a related-point HMRC has been asked for its view on the tax treatment arising where a director repays a bonus in consequence of COVID-19. For example, where a director has recently received a bonus by reference to last year and would now like to repay the bonus in view of COVID-19 and furloughing to help maintain liquidity and working capital for their employer and mitigate negative press from furloughing employees.

Our understanding is that a voluntary repayment is not considered eligible for relief as negative earnings, as the repayment has to arise from a contractual obligation, and HMRC has therefore been asked whether government would relax the contractual requirement for a temporary period, so that voluntary bonus repayments made to reduce financial strain due to COVID-19 will be accepted as negative earnings.

By Matthew Brown, CIOT Technical Officer