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Employment Income Manual

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Employment income provided through third parties: exclusions: earmarking of deferred remuneration: conditions: examples

Section 554H(1) and (2) ITEPA 2003

Specified conditions: bad leavers
Specified conditions: gross misconduct
Specified conditions: deferred remuneration received early
Specified conditions: conditions later lifted

Here are some examples illustrating the conditions in Section 554H (exclusions: earmarking of deferred remuneration).

On the conditions in Section 554H generally, see EIM45255.

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Specified conditions: bad leavers

Even if the only circumstances that would result in the specified conditions failing to be met are that the employee departs from the employment as a ‘bad leaver’, this test can still be passed provided that it is realistic to suppose that the terms of the bad leaver clause could be satisfied.

But this will only apply if it is clear that the employee cannot expect to receive the reward if the conditions for forfeiture are triggered.

Note that ‘bad leaver’ is a commercial term; for tax purposes, what matters is whether the statutory conditions are met.

Whether or not the ‘reasonable chance’ test is passed will depend on the facts of the case.

But the specified conditions must be genuine and not amount to guaranteed remuneration, just at a future date.

Where ‘bad leaver’ clauses include a provision for the remuneration committee or Board to exercise its discretion to override the rules in exceptional circumstances, the terms of awards can still be capable of meeting the condition in Section 554H(1)(e) namely, if there is a reasonable chance that the award is revoked because the conditions for obtaining it have not been met.

In other words, awards on such terms will be capable of coming within the earmarking exclusion in Section 554H for deferred awards.

But, again, whether an award on such terms comes within Section 554H will depend on the facts of the case. And the conditions, when looked at against any residual discretion of the remuneration committee, must be genuine.

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Specified conditions: gross misconduct

Suppose that the specified conditions would fail to be met if but only if the employee was dismissed for gross misconduct.

Gross misconduct is a single act of misconduct that is serious enough on its own to justify the employee’s immediate dismissal.

Realistically, an employer is not going to make an award of deferred remuneration to an employee whom the employer reasonably expects to dismiss for gross misconduct before the award vests.

The ‘reasonable chance’ test must be passed at the time when the award is made.

Therefore, in this scenario, there is no reasonable chance that the award will be revoked. And so the ‘reasonable chance’ test is not passed.

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Specified conditions: deferred remuneration received early

Suppose A receives the deferred remuneration:

  • before the vesting date, or
  • before the specified conditions have been met, or
  • both.

As long as this early receipt does not cast any doubt on the genuine nature of the original deferral, it will not withdraw the shelter of Section 554H from the original relevant step and there will be no retrospective charge.

But, if the early receipt does not attract PAYE, a fall-back charge will apply at the end of the vesting date. See EIM45270.

If A receives the deferred remuneration early from P, P will take a relevant step within Section554C at that point. See EIM45060. If the statutory conditions are met, this will give rise to Part 7A income attracting PAYE.

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Specified conditions: conditions later lifted

Suppose:

  • an award is made on terms which satisfy Section 554H(1),
  • after (say) one year, some of the conditions are lifted, and
  • as at the time when the conditions are lifted, there is no reasonable chance that the award will be revoked.

Section 554H imposes seven tests on the award of deferred remuneration (see EIM45255). You apply these seven tests at the time when the award is made. Therefore, if an award passes these tests at the time when it is made, and later on some of the conditions are lifted, that will not automatically take the award outside Section 554H.

But you need to find out why the conditions were lifted.

  • If there is doubt about the genuineness of the conditions, the ‘main purpose’ test may be failed.
  • If the conditions were made, or lifted, or both in the hope of avoiding tax, the ‘tax avoidance’ test will be failed.