To really demonstrate that "we are all in this together", a number of senior employees and officers in professional positions have announced that they will waive part, or even all, of their salaries at the present time. However, notwithstanding the spontaneity of such a response, the good deed will need to be tempered by careful planning, otherwise both employee and their employer could suffer a tax bill.
Timing is key to avoiding an unwanted tax bill in connection with a waiver of salary. That is because the general rule is that if a waiver of salary happens after the earnings are treated as having been received, the employee remains liable to income tax and NICs on the amount waived. Accordingly, the employer is liable to NICs and must operate PAYE in the usual way. So, the wavier may be valid, but the tax liability still accrues, and HMRC would be able to pursue employer and employee for unpaid amounts.
To avoid this, it is vital that any waiver is formalised before the salary is treated as received. HMRC's guidance says:
"If an employee and employer agree to a reduction in the employee’s remuneration before they are paid, eg to support company cashflow during the pandemic, then no Income Tax or National Insurance contributions (NICs) will be due on the amount given up. This is provided the agreement is not part of any wider arrangement to divert the amount to a particular recipient or a cause."
So, when are earnings treated as received? For an employee, earnings are received on the earlier of (i) when a payment of earnings is actually made or when a payment on account of earnings is made, or (ii) the time when a person becomes entitled to payment or earnings or a payment on account of earnings.
However, for directors the rules are more nuanced with the somewhat counterintuitive result, in some cases, of bringing the forward the “tax point” to a time when the director is not actually able access the earnings. This could catch out owner-managers of businesses.
Having ascertained the right timing, how is a waiver formalised? A waiver of remuneration happens when an employee gives up rights to remuneration and gets nothing in return. This should be formalised in a deed of waiver or a contract variation (consistent with any variation provisions in the contract of employment). An employee or director will usually want to secure clarity in that agreement about exactly what is to be waived (and for how long), as well as confirmation that the other terms and conditions (and any benefits) of the employment will continue unaffected. For clarity, the variation instrument should also address the effect of a temporary salary waiver on those benefits which are referable to salary (e.g. pension, life assurance). However, if lockdown presents a challenge to formally execute paperwork, confirmation in an email of the intention to waive and confirming the new position on both sides should be acceptable.
It is also worth noting that earnings may comprise different elements - an employee or director may be contractually entitled to a bonus. In the current circumstances, a senior person may be willing to repay a bonus to support working capital and liquidity of the business so as to balance the business taking advantage of government assistance, such as the employee furlough scheme.
HMRC's guidance says:
"It is possible to give back salary or bonuses to a business or employer after they have been paid. However, it is not possible to claim back the Income Tax and NICs that would already have been deducted from the salary or bonuses on payment. Bonuses must be waived before the date they are due to be paid. If they are waived on or after the due date then tax will still be payable on them, even if the bonus is not paid over."
It seems, therefore, that HMRC does not consider negative earnings could arise with possible associated credits on tax paid or loss relief.
There are also other practical matters for the individual to consider. The individual may seek to negotiate some kind of comfort with the employer that the business would make them whole again once the situation returns to normal / the pre-pandemic position? This could take the form of a salary review and rise, or repayment of a deferred amount. In such cases the tax position would need to be reviewed too.
And what about shareholders (whether not they are employees) wanting to waive the right to be paid dividends? In a similar vein, the waiver must be in place before the right to receive a dividend arises. For final dividends, this is before they are formally declared and approved by the shareholders. For interim dividends, the waiver must be in place before the dividends are paid. For this to be effective, a deed of waiver must be formally executed, dated and signed by shareholders and witnessed and returned to the company.
So, whilst recent changes to some tax and related rules do acknowledge certain challenges presented by the present unusual situation, it is unfortunate that HMRC and the government have not taken a similar approach and afforded latitude to the application of the rules on taxation of waived remuneration. Instead, the taxpayer must search out guidance to understand how to avoid charges that would otherwise arise if they mistime their good deed.
Therefore, please do seek appropriate advice before waiving or repaying any part of your remuneration. We can ensure you are able to make the most of your generous decision.