Conditional bonuses - when earnings are 'for'?

To what extent FTT ruling in Murphy v HMRC [2019] UKFTT 409 can be relied on?

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My client received two bonuses which were calculated in reference to his employer's accounting period (year to 31 July 2020). Bonus awards were declared and paid at employer's absolute discretion during 2020/21 tax year.  The amount of the award was calculated in reference to targets and results achieved during the reference period to 31 July 2020 but subject to further conditions. The first bonus award was granted in early October 2020 to individuals who were in active employment with the employer throughout the reference period (year to 31 July 2020) and who remained in employment until the payment date. No awards were granted to persons that met the conditions listed above but who have announced their resignation prior to the payment date. The second bonus (of equal amount to the first one) was paid in early March 2021. It related to the same reference period and was subject to the same conditions as above plus an additional requirement that the employer's company also meets financial targets set out for the first 6 months of the next financial year i.e. period from 1 August 2020 to 31 January 2021. 

The taxpayer was UK resident for the year to 5 April 2020 (working in the UK) and non-resident for the year to 5 April 2021 (no UK home, 10 UK midnights, 6 UK workdays). The employer recognised a corresponding cost in the company's accounts for the year ended 31 July 2021 (consistent with treatment of past bonuses as adopted in their audited accounts for the previous years). For bonus payments made to my client in 2020/21, the employer applied a NT code via PAYE (NICs were assessed on the full amount). It is also worth pointing out that employees receive modest salaries and  bonuses represent the main element of their total remuneration package thus it is quite rare for employees to leave before bonus payment dates (although there were a few such instances - and those cases no bonuses were paid).  

The fundamental concept to refer to when working out UK taxable proportion is earnings 'for' tax year in s16 ITEPA 2003. HMRC interpretation of what constitute earnings 'for' tax year under s16 derives from Lord Oliver's ruling in Bray v Best. EIM40008: 

[...] The case of Bray v Best (61 TC 705), was heard by the House of Lords in 1988. Lord Oliver set out the preferred approach at page 752:

“The period to which any given payment is attributed is a question to be determined as one of fact in each case, depending upon all of the circumstances, including its source and the intention of the payer so far as it can be gathered either from direct evidence or from the surrounding circumstances.”

Lord Oliver’s approach to determining the year that earnings are “for” continues to apply. Section 16 simply confirms the recommended approach.

EIM40011 further states that when trying to evidence employer's intention the "essential starting point is to obtain contemporaneous evidence. This may include all or any of the following: an understanding of the intention of the employer in developing the incentive programmes; bonus plans; award letters; notes of meetings; correspondence between the parties; obtain an analysis of amounts paid out; an explanation of how awards are treated in the employer-company accounts".

Unfortunately, the taxpayer's employer did not provide a clear and conclusive written explanation other than a confirmation on how the amounts were recognised in the accounts (in the period in which entitlement is established and becomes payable i.e. 2019/20 tax year). 

Furthermore, the facts are somewhat similar to Murphy v HMRC [2019] UKFTT 409. The case did not create a precendent as it is a First-tier Tribuanl ruling but the conculsion reached by FTT is against HMRC guidance. FTT found that Lord Oliver's decision is not helpful or relevant as s16 contains its own explanation of the meaing of 'for' a particular tax year. The judge reviewed the conditions that needed to be met in order for Mr Murphy to be awarded and receive a retantion payment. The judge noted that in absence of accruing right to some or all of the retention payment, the payment was not earned during the retention period. Further, while it was a reward for continuing in active employment until the payment date, it was awarded in respect of being employed at the payment date and therefore represent general earnings for the year in which the entitlment is established. HMRC did not issue any official statement in relation to this finding (perhaps unsuprisigly as it is just an FTT ruling). No changes were made to HMRC manuals to explain their position in light of this finding (at least none that I am aware of). 

So the question is shall the FTT decision in Murphy v HMRC be disregarded or shall one consider the point at which an unfettered right to receive earnings is established when deciding what tax year earnigns are for? Is it reasonable to align earnings 'for' tax year for personal tax purposes with accounting treatment adopted by the employer's company's accounts and how likely HMRC is to challenge this? If anyone supported their arguments with references to Murphy case and secured a successful outcome in dealings with HMRC, it would be very helpful to hear their feedback. Any thoughts would be much appreciated.  

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By Justin Bryant
16th Aug 2021 17:29

The position of HMRC in Murphy conflicts with their own manual but can seemingly be applied in the EBT / EFRBS cases where the charge falls under s62 (or P7A which incorporates these principles). HMRC did not succeed on this s16 narrow scope point but did win on the non-allocation point (i.e. the payment could not be attributed to a period of non-UK residence, so it fell to be attributed to the year it was received – when the taxpayer was UK resident). A trite summary is below re S15 / s16 ITEPA interaction which does not cover this case; just the standard position:

1. Earnings (salary etc) are charged to tax when they are received (https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim42220) and see ITEPA 2003 s15(2). As will be seen below the term “received” is wider than simply receiving payment (and wider still for company directors).
2. The tax year to which the charge is attributed is the tax year when the income (i.e. salary/bonus) was earned (See https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim40008) and ITEPA 2003 s16. This rule in practice only comes into play where salary was earned in a tax year(s) of non-UK residence but received in a year of UK residence or vice versa. It also applies where salary is earned in the overseas part of a split year.
3. The effect of these two rules is that if earnings (e.g. salary but more likely a bonus) are received by a UK resident but attributed to a period of non-UK residence (and when all work was performed outside the UK) the earnings are not taxed in the UK. Conversely if the earnings are received in a year of non-UK residence but attributed to a year of UK residence then they are taxed as earnings in the UK. This rule in s16 commonly applies to bonuses which are often received after the period they were earned.
4. If earnings (e.g. a bonus) is received in, say, the 2020/2021 tax year but was earned over a performance period which ran through the 2015/2016, 2016/2017, and 2018/2019 tax years, the bonus falls to be taxed 100% in 2020/2021. It is not apportioned between those years retrospectively. But if the 2015/2016 tax year was a year of non-UK residence with no work performed in the UK, the part of the payment attributed to that 2015/2016 tax year would not be taxed in the UK.

Refer to paras 20 onwards re HMRC’s arguments in trying to limit the scope of s16 ITEPA 2003 which incorporates Bray v Best:
https://www.casemine.com/judgement/uk/5d1d92cf2c94e018dbfc455e

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By richard thomas
16th Aug 2021 18:42

I recommend you look at the binding decision in Keith Murphy v Revenue and Customs [2021] UKUT 152 (TCC).

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By Justin Bryant
17th Aug 2021 10:11
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Replying to Justin Bryant:
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By richard thomas
18th Aug 2021 12:05

All I can say (given what the appellants in the UT case were) is: It’s a fair cop, guv!

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By Justin Bryant
04th Aug 2022 13:28

Fyi that has now been reversed by CoA. See: https://www.bailii.org/ew/cases/EWCA/Civ/2022/1112.html

No doubt KG will be opining on that. See: https://www.taxadvisermagazine.com/article/murphy%E2%80%99s-law

It seems that drafting of the settlement agreement remains important per KG's above comments.

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