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HMRC internal manual

Employment Income Manual

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HM Revenue & Customs
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The year that earnings are “for” - bonuses and deferred remuneration plans - the effect of conditionality and employer's discretion

ConditionalityMany bonus schemes are referenced to performance periods, but awards will not be paid unless employees are in employment on the date of payment. For example, a bonus is referenced to company profits for year ended 31 December but is not paid until the following 30 June. Employees who worked for the employer during the performance year forfeit their entitlement if they leave employment before 30 June.

Up to 28 February 2008, HMRC took the view that the bonus award could only be “for” the year in which unfettered entitlement to receive it arose. The year that the bonus was “for” was the year in which the employment condition was satisfied. Since 28 February 2008, HMRC has adopted the principles set out in EIM40008 and subsequent pages.

Good and bad leaversMany of the plans with employment conditions identify “good” and “bad” leavers and prescribe different treatments for the two categories. “Good leavers” are employees who cease employment before the bonus payment date through retirement, redundancy or ill-health. “Bad leavers” are those who are dismissed for cause or resign to join a competitor.

It is possible to take various views on the year that such bonus awards are “for” where there is an employment condition:

  • The performance period
  • The performance period plus the period from the end of the performance period to the date of payment, sometimes referred to as the “vesting period”
  • The year in which the date of payment fallsYour decision should take account of what the bonus scheme is intended to achieve. If this is not clear from the documents, you may base judgments on how the employer treats good and bad leavers.

Plans that:

  • are designed to provide incentives to employees for performance periods, but,
  • do not pay out unless the participants are still in employment at the specified date, but,
  • do not specify any additional performance conditions in the period beginning after the original performance period and ending on the payment date,are likely to pay out awards that are “for” the original performance period. However, if the Plan introduces additional performance conditions for the second period the period that the award is “for” is likely to be the aggregate of both periods.

If “good leavers” are entitled to receive awards; that may indicate that the awards are “for” the original performance period. Entitlement to pro-rated awards may indicate that entitlement is “for” the performance and the vesting periods.

Some schemes provide for deferred bonuses to be paid out when ownership of the company changes hands. This may be an indicator that the bonus is earned by that date and is “for” the relevant performance period.

Even though these contingencies may not occur for all or any of the plan participants, their existence may shed light on the period the bonus is intended to be “for”.

It is sometimes argued that the employment condition is never just about being in employment on the specified date; that the intention of the employer in introducing this condition is to obtain satisfactory performance in the period ending on the date of payment. This may well be the case. If evidence can be found to support the contention you should accept that the period the awards from the Plan are “for” is the combined performance and vesting periods.

Employers’ discretionSome bonus schemes give the employer absolute discretion to award or refuse to award bonuses. The discretion may lie with the trustees if an Employee Benefit Trust (EBT) pays out the awards. The Courts have held that, whatever the Plan says, an employer’s discretion in awarding or withholding a bonus is not unfettered. However wide the discretion appears to be, the employer is required to exercise his discretion rationally and in good faith, and not irrationally or perversely.

There may be a pattern of awards that may indicate the year the awards are “for”. Employees may also have an understanding of how the bonus scheme works, and the period awards are referenced to, while accepting the employer’s discretion.

A discretionary bonus may therefore be “for” the performance period, the combined performance and “vesting” period or the year in which discretion is exercised and payment is made. It is important to consider all of the relevant information.