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HMRC internal manual

Employment Income Manual

Employment income: negative emoluments: the law before ITEPA

Employment loss relief

ITEPA became effective on 6 April 2003. At that time, employment loss relief was provided by section 380 ICTA 1988, which also covered losses in any trade, profession or vocation. It was replaced in relation to employment loss relief by section 128 ITA 2007. There is no case law authority that considered how section 380 might operate in the context of employment. However, the point was briefly touched on in HMRC (previously Inland Revenue) published guidance, which stated:

An employee’s title to relief should not be admitted unless the loss arises directly from the conditions of the employment. The employee must be contractually obliged to suffer a part of the employer’s losses. Examples include:

  • a departmental manager remunerated by a percentage of the profits of their department and responsible for a corresponding percentage of any losses, or
  • a commercial traveller responsible for bad debts arising from orders obtained by him or her

Before ITEPA, the charge to tax for employment income was under Schedule E, in relation to “emoluments”. As stated by Judge Warren in HMRC v Julian Martin:

“A taxpayer’s liability under Schedule E was a function of his emoluments with allowance being made for certain deductions against those emoluments. There was no express mention of the possibility that emoluments might be negative (or anything resembling that possibility) and there was no express mention of the possibility of a payment by an employee reducing the total amount of his emoluments (in contrast with deductions being allowed from those total emoluments in calculating the employee’s tax liability).”

Prevailing practice

At the Upper Tribunal, Counsel for Mr Martin submitted that the prevailing practice of the Inland Revenue at the time that the legislation in ITEPA 2003 was being drafted was to allow repayment of income tax suffered on earnings which, due to contractual terms, were subsequently repaid to the employer, referring to British Railway Board v Franklin as an example.

Just as the HMRC published guidance should only be taken as HMRC’s view of the application of the law in particular circumstances, a prevailing practice may not be taken as a statement of law. By virtue of the existence of the practice allowing repayment of income tax in particular circumstances, the point of law was not tested.

In British Railway Board v Franklin (see EIM00815), whilst the Court of Appeal accepted the explanation given by the Inland Revenue that the tax and NIC would be refunded, Nolan LJ stated:

“while the treatment accorded to the Clause 9 payments by the Revenue and the DSS produces as fair and sensible result, I would not wish to be taken as expressing a view one way or the other on its correctness as a matter of law.”