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Negative and positive | accountingweb | Tax treatment of negative earnings
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What happens when taxable earnings go negative?

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Ian Holloway looks at what to take away from HMRC’s latest guidance on the tax treatment of negative earnings.

10th Aug 2023
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Legislation refers to net taxable earnings – the part of taxable earnings on which income tax is paid. Yet, what happens if there are no net taxable earnings and, in fact, they go negative? Given that negative taxable earnings are a feature of the tax system, HMRC’s new guidance on 25 July 2023 about claiming a tax refund is to be welcomed.

The Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) refers to the calculation of the earnings subject to an income tax liability, focusing on income received. This is the value of taxable earnings after considering deductions, such as any personal allowance entitlement, pension contributions, payroll giving and so on. Taxable earnings are not the same as net taxable earnings.

The 2003 Act, however, does consider the fact an individual may have received annual net taxable earnings that are either nil or negative. It is irrelevant that neither nil nor negative net taxable earnings appear as statutory definitions, ITEPA 11 (2 and 3) refers to the fact they are a reality.

Nil earnings occur when the value of net taxable earnings are exactly outweighed by the value of deductions. Or, where there are negative taxable earnings but, as far as payroll is concerned, they are treated as being equal to zero.

Negative taxable earnings are where, for one reason or another, over the course of the tax year, net taxable earnings are negative. So, income is received but is sent into a negative situation, possibly as a result of a contractual arrangement referred to as a “clawback provision”. Here are some examples:

  • a woman receives an occupational maternity payment, repayable if she does not return to work (or does not remain in employment for a required period)
  • a “signing-on bonus” that specifies a minimum service requirement
  • bonuses to bankers, repayable where there is a breach of Prudential Regulation Authority (PRA) rules.

Bonus clawbacks

HMRC’s new guidance does not refer to all possible causes of negative earnings, only those as a result of bonus clawbacks described as “the most common”.

Perhaps, this is guidance issued as a result of 2014 case law determined in HMRC vs Julian Martin which said, importantly:

  • The original (positive) payment to the employee must have been made as a result of employment. Therefore, even though subject to a clawback, the payment must have been correct, in other words not as a result of paying the wrong employee.
  • The clawback payment can only give rise to negative net taxable earnings appropriate to the tax year in which it was made.
  • The employee must have made a payment to the employer, in other words, the clawback.

Action for the employer 

For the employer who has clawed back, the guidance says the advice to the employee should be there is no income tax refund due via PAYE, as the payment at the time was correct. This is because ITEPA 18 only makes provision for positive payments. There is no similar provision for negative earnings, something expanded in HMRC’s Employment Income Manual (EIM) page 00840

The fact we do make refunds of income tax in the payroll all comes down to the definition of negative earnings (EIM00835) and adjustment of earnings is often as a result of a previous overpayment.

Action for the employee

For the employee who has made the clawback payment, the guidance says they must check whether they have gone into a negative net taxable pay situation for that tax year. The guidance advises on this process, plus EIM00844 and EIM00845 give examples, albeit they relate to tax year 2016/17. The employee may be able to claim a refund of income tax which can be applied to any other income in that tax year or applied to the previous tax year. This provision is contained in 128 of the Income Tax Act 2007

Plus, thankfully, the guidance is clear the employee cannot get any refund from the employer. They must:

  • register for self assessment (if they have not done so already)
  • for the applicable tax year, adjust the taxable pay by the value of the negative sum including an explanation in the “Any other information about this employment” box
  • file the self assessment return
  • then wait!

There is also guidance on how employees can write to HMRC if they are unable to claim via self assessment.

Cumulative liability

Income tax is an annual liability, in other words, cumulative. The Social Security (Contributions) Regulations 2001 and Northern Ireland equivalent says earnings subject to national insurance contributions, save for directors, are a liability incurred each time the employee is paid, meaning non-cumulative.

So, on the assumption the payment being clawed back was paid by reason of employment and was not in error, national insurance is due at the time the payment was made. There is no provision for negative pay for national insurance purposes, therefore, no reclaim can be made. Section 52 of the above regulations refers to “contributions paid in error”. At the time the payment was made, there was no error! 

It is, however, worth pointing the employee to HMRC’s National Insurance: general enquiries or advising them to write to HMRC at their Kent post box address (PT Operations North East England HM Revenue and Customs, BX9 1AN).

Replies (2)

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By richard thomas
11th Aug 2023 21:40

Thank you, Ian, for alerting us to the new gov.uk level guidance from HMRC. I have looked at it and can say that it is by HMRC’s standards reasonably good as an explanation of the concept, but finishes badly when discussing what the employee had to do to give effect to their rights (more on that later).

You have also sent me to the EIM guidance on this issue, which remarkably for HMRC manuals is actually too technical for its own good, because the lengthy commentary on the Martin decision in the UT is mostly unnecessary and is a product of Mr Justice Warren’s over-pedantic style of decision writing being difficult to follow. It also unforgivably, after correctly calling him Mr Justice Warren goes on to call him Judge Warren (which he was not) and at one point Judge Martin! It also misinterprets him in a potentially important way, also more on which below.

I wish I could be as complimentary about your article. I am perplexed by some of your terms which are unfamiliar to me, though I recognise they may be familiar to accountants working in the field of employment tax. And I think in places you are wrong. And you reproduce some of HMRC’s errors without comment.

You say:

“The Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) refers to the calculation of the earnings subject to an income tax liability, focusing on income received. This is the value of taxable earnings after considering deductions, such as any personal allowance entitlement, pension contributions, payroll giving and so on. Taxable earnings are not the same as net taxable earnings.”

I think that your first sentence is a reference to section (or s) 9(2) and (3) ITEPA (not please, as you put later, “ITEPA 11” or “(2 and 4)” – each subsection has its own pair of brackets)) which are part of a calculation provision. I do not understand why you add the reference to “focusing on income received” or what, in the next sentence, “This” is meant to refer to: if it is to the calculation of “net taxable earnings” in s 11 then it is plain wrong. The only deductions in arriving at a net figure are those set out in s 11(1), in the definition of DE, those listed in s 327(3) to (5) ITEPA. These are, broadly, expense deductions, capital allowances, payroll giving amounts and pension contributions. Personal allowances do not come into the equation at this point, but at step 3 in s 23 ITA 2007

Then

“The 2003 Act, however, does consider the fact an individual may have received annual net taxable earnings that are either nil or negative. It is irrelevant that neither nil nor negative net taxable earnings appear as statutory definitions, ITEPA 11 (2 and 3) refers to the fact they are a reality.”

I am really perplexed by this. How can you “receive” nil or negative earnings? And what is meant by an Act of Parliament “consider[ing] a fact”? And what is it irrelevant to that there is no statutory definition of either nil or negative net taxable earnings. There doesn’t need to be as the terms are not used anywhere in the Act. In any case “nil (taxable) earnings” is not I think standard English usage, unlike earnings “taken to be nil” in s 11(2) (but Hugo Fair is the expert here). If TE-DE = 0 then there are no taxable earnings or the earnings are nil.

Then

“Nil earnings occur when the value of net taxable earnings are exactly outweighed by the value of deductions. Or, where there are negative taxable earnings but, as far as payroll is concerned, they are treated as being equal to zero.”

First sentence: No - Nil earnings occur when the value of [ ] taxable earnings are exactly outweighed by the value of deductions (TE – DE). Second sentence: Not just when TE is negative, but also when TE – DE is negative, irrespective of whether TE is positive, nil or negative. And what’s payroll got to do with it?

Then

“Negative taxable earnings are where, for one reason or another, over the course of the tax year, net taxable earnings are negative. So, income is received but is sent into a negative situation, possibly as a result of a contractual arrangement referred to as a ‘clawback provision’.”

What does the first sentence tell us apart from the fact that negative taxable earnings are negative taxable earnings? The second sentence does not describe the only case. The clawback may be paid in a tax year when there are no positive earnings.

Under the heading “Bonus Clawbacks” you suggest that this guidance was issued as a result of the UT Martin decision. But that was in 2014, and the EIM has had the guidance you cross-refer to since at least 2016.

Under the heading “Action for the employer”, you say:

“For the employer who has clawed back, the guidance says the advice to the employee should be there is no income tax refund due via PAYE, as the payment at the time was correct. This is because ITEPA 18 only makes provision for positive payments. There is no similar provision for negative earnings, something expanded in HMRC’s Employment Income Manual (EIM) page 00840.”

The first sentence correctly states the reason why there is no refund of PAYE by the employer. So why does the second sentence purport to give another explanation? And I fail to see what s 18 ITEPA (what I assume you mean) has to do with this scenario, as it is simply a timing rule for payments determining in which tax year amounts of earnings fall to be taxed. EIM 00840 discusses whether s 18 applies to clawback amounts and concludes from what is said in Martin UT that it does not. In so doing HMRC have fallen into one of the commonest traps of amateur interpreters of case law, that is assuming that what is said about the factual situation of the case under appeal applies generally – in Martin there were actual payments made. Nothing Warren J said can be taken as applying eg to a case where the positive amounts were simply credited to a DLA and not drawn, with the clawback simply cancelling or reducing the entry.

You seem to agree with HMRC, though. Any reason for that?

Then

“The fact we do make refunds of income tax in the payroll all comes down to the definition of negative earnings (EIM00835) and adjustment of earnings is often as a result of a previous overpayment.”

Eh? What’s EIM 00835 got to do with making PAYE refunds?

Under the heading “Action for the employee”, you say:

“The employee may be able to claim a refund of income tax which can be applied to any other income in that tax year or applied to the previous tax year. This provision is contained in 128 of the Income Tax Act 2007.”

The claim in s 128 though is to set an employment loss (ie the amount of negative TE for the year) against general income for the year of loss or the previous year, or both. Whether this results in a repayment of tax or a credit against other liabilities or the cancellation of an amount of an assessment depends entirely on the facts of the case (no doubt why HMRC’s guidance is not as clearcut as your account of it). Even if a tax repayment may result from the claim it is incorrect to say that it is the repayment which is “applied” to general income, it is the loss (negative TE) if anything.

And also:

“Plus, thankfully, the guidance is clear the employee cannot get any refund from the employer.

They must:

• register for self assessment (if they have not done so already)

• for the applicable tax year, adjust the taxable pay by the value of the negative sum including an explanation in the “Any other information about this employment” box

• file the self assessment return

• then wait!”

While I agree you have faithfully reproduced the 5 bullets in the guidance “How to claim loss relief or a tax refund as an employee”, you do not comment on them, the paragraph in the guidance above it, or the guidance on “Checking if you can claim loss relief or a tax refund” so I will. But you should not say that employees “must” register for SA to get relief – even HMRC do not say that, though they nudge you in that direction.

Note that both headings refer to two possible cases, a loss relief claim (ie under s 128 ITA 2007) or a tax refund (where TE is still positive after deducting the clawback). I think you have mixed the two up in your passage about s 128.

HMRC’s error is to think that you cannot have both cases (see guidance under “Checking if you can claim loss relief or a tax refund”). But you can, if TE is negative. Assume earnings are £100,000 from which PAYE is deducted, and that clawback is £150,000. Taxable earnings are therefore nil, and so, ceteris paribus, the PAYE tax deducted can be recovered through the self-assessment mechanism, and it may well be that s 59B(1) TMA will give a repayable amount.

In addition a s 128 claim many be made against general income of CY, PY or both in the amount of £50,000. In the case of CY the relief is (supposed to be – see below) claimed in the return and SA: for PY Schedule 1B will generate a free-standing credit.

Someone with a clawback less than taxable earnings will have an amount of PAYE in box of the employment pages greater than it would have been if PAYE had only applied to the balance and that may lead to a repayable amount under s 59B(1) (or may not depending on other liabilities in the return and SA). They won’t have a s 128 claim.

Similarly if there are no earnings, only a clawback, the only relief will be through a s 128 claim.

Immediately under the second heading, “How to claim loss relief or a tax refund as an employee” (which also refers to both types of relief), HMRC say:

“You should claim the appropriate amount of tax deducted in the year that you made the repayment. You do this using Self Assessment if you already complete a Self Assessment return. Check the Self Assessment criteria. If you do not use Self Assessment you can write to HMRC.”

This seems to be about the “tax refund” of PAYE only. It is dressing up as a “claim” that which every employee within SA is told to do anyway which is to put the P60 or P45 tax figures in box 2. It hardly needs to be included in this guidance. Why do HMRC then mention the SA criteria? If you are already within SA you don’t need to look at the criteria. The last sentence wisely tells anyone not within SA not to “register” but to write to HMRC so that the “clawback” can be deducted from the P60/P45 amount of earnings resulting either in a reduced underpayment for coding or simple assessing or a repayment made with the P800. When you think about it the non-SA case with a genuine clawback is going to be rare as it only happens to the highly paid. There is though an example about maternity care which may well apply to the non-SA case.

The 5 bullets then follow on without any indication how they relate to the first paragraph. The first says you “should” register for SA if not already registered. This differs from the first paragraph which is entirely neutral and simply gives you a different route if you are in SA or not. So why the change in approach? And it does not say why you need to register by 5 October or why you need to register at all.

The second bullet makes you choose between the two reliefs even though you might be entitled to both. It tells you to reduce the figure of earnings (box 1 of the EMP pages) but does not tell you what to do about any employment loss despite it being for loss relief as well as PAYE tax refund.

The reason it doesn’t tell you is simple. There is nowhere on the tax return to enter an employment loss claim. This despite the trouble HMRC caused when accusing Mr Tooth of fraudulent tax evasion for putting an employment loss in a different loss box because there wasn’t one for the loss he actually incurred. Despite the Supreme Court’s blistering put down of the HMRC case in Tooth in 2021, so far as I know there is nothing in the current return to allow an employment loss to be entered. TCSN (2023) still shows nothing for employment losses.

Is there EIM guidance to help? Of the 4 examples of negative taxable earnings, the second at EIM00843 says at the end:

“Loss relief will be available under section 128 ITA 2007 of £50,000 (see EIM32866).”

So off one goes to EIM 32866 to find nothing of any help about the mechanics of claiming.

If there is a s 128 claim available, because TE is negative, then the failure of HMRC to allow the loss to be shown in a return leads to the conclusion that a s 128 claim is always within Schedule 1A TMA. But why don’t HMRC say that or discuss the loss position.

The final paragraph after the bullets covers people who cannot claim using self-assessment. Who is this meant to cover if everyone “should” register. Of course no one needs to “register” for SA to either reduce the taxable earnings figure or claim employment loss relief. And in fact as I have pointed out everyone who has a s 128 claim should do it outside a return.

I have nothing to say about the text under “Cumulative liability” except to say that it is a misleading heading – the subject is Class 1 NICs. And it is “regulation”, not “section”, 52.

So I recommend to the Accounting Web readership that they simply follow your links to the guidance for enlightenment as to what negative earnings is about and then do their best for their clients in the usual way if a claimant has any negative earnings, not relying on anything HMRC say.

Thanks (8)
Replying to richard thomas:
Chris Caspell CTA TEP
By ccaspell
14th Aug 2023 17:28

Ouch!

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