Background
George is a production manager in Elixir, the UK subsidiary of an international electronics firm and he considers that he is fortunate to earn more than the national average salary. While his income is not yet subject to the 40% “higher” rate of tax, it is just on the margins. George’s firm has an incentive scheme designed to reward staff who make valuable suggestions which benefit the firm’s performance and George, together with a young colleague Dean, made a suggestion which removed a production bottleneck and resulted in a measurable improvement in productivity.
As a result of this suggestion, George and Dean were each awarded a bonus of £5,000 but have been advised that, because of the timing of the announcement, there is a bit of uncertainty whether the award can be processed in time to include it in the March payroll. Both men were delighted to receive the award and Dean, who is still struggling to pay for his Christmas holiday in Thailand, is very keen to ensure that payment will be made in March. George, on the other hand calculates that this bonus will push him over the tax threshold, so that £4,000 of his bonus will be subject to tax at 40%, rather than the 20% rate which would be applied to the rest of his income. Dean earns less than George who assumed that none of Dean’s bonus would be subject to more than 20% tax.
George feels very aggrieved that he might have to pay twice as much tax as Dean and wonders whether he can do anything about it, since it will make a big difference to what he and his wife can spend on the new kitchen they have long been planning. That evening he discusses the matter with his wife who tells him that he must speak to whoever organises the company payroll and see that payment is not made until April.
The next morning, George tells Dean that he is going to see Nicola, his HR Manager who is responsible for organising the company payroll, to try to get the payments delayed until April, because it will save him nearly £1000 in tax. Dean does not respond.
When George meets Nicola she congratulates him, saying that he will no doubt be pleased to learn that she is confident that she will be able to get the award payments included with the March salaries. George looks horrified and Nicola asks him what is wrong. “That will cost me £800” he replies and explains why, adding that he was sure that Nicola and Elixir would be sympathetic towards him. Nicola is taken aback at this saying that she did not realise that and would have to think what could be done and there is very little time.
George returns to work leaving Nicola with a dilemma. In trying to accommodate Dean’s need to receive his award payment as soon as possible she in danger not only of upsetting George, but actually costing him money and Nicola worries whether she will be able to satisfy both Dean and George.
Although Nicola has not said that she can do anything to help either George or Dean, she arranges to speak to Richard, the Finance Director with whom she shares her dilemma. Richard says that he quite understands George’s feelings, but income tax is something that everyone has to pay and the company avoids getting involved in any sort of manoeuvres that might attract unwelcome publicity. In any event, the award was made during the current year and will be included in the report and accounts for the year just ending. Accordingly, Elixir has no real justification for delaying the payment until the following year.
At the same time as George and Dean are awarded their bonus, the Board of Elixir’s parent consider the anticipated group results which are particularly good, as a result of which a proposal is discussed to award Walter, Elixir’s Managing Director, a bonus of £100,000. At the meeting when the decision is ratified, a member of the compensation committee suggests that it would be sensible if they consider how to make the payment in a tax efficient manner. If they delay payment until the following year, a lower tax rate would be in force thus saving Walter some £5,000 in tax.
A member comments that they should be aware that any apparent delay to an award simply to permit Walter to benefit from a lower rate of tax might attract unwelcome publicity. The Chairman says that is a justifiable risk, but losing a key executive because you do not offer a sufficiently attractive compensation package is not. The committee do not demur at this, and agree that the “bonus” should be paid in the form of a retention payment, which could justifiably be made once the lower tax rate applies.
In due course the executive team of Elixir meet and the final results for the year are discussed, including the funding of end of year bonus payments. Richard has been pondering what Nicola had said to him about the tax impact on George’s bonus of it being taxed at a higher rate and what, if anything, Elixir might or should do to help him. Accordingly, at the end of the meeting he raises the matter as a topic of general interest for consideration by the executive team, in the light of the public debate about the morality of deferral for tax purposes of bankers’ bonuses which reward people who are already highly paid, in the knowledge that a lower top rate of tax would apply in the following year.
Walter says that he does not see it as an issue; it is really no different to suggesting that someone should not be awarded a pay rise if it would take them into a higher tax bracket and that companies should try instead to find alternative means of rewarding their staff. That approach, he adds is what, had led to the rash of non or low tax items such as company cars and “entertainment allowances” which had been paid until they were made unattractive by subsequent tax charges being imposed on them by the Inland Revenue.
As the other members of the team nod in apparent agreement with Walter, Richard, who is unaware of the pending award to the Chief Executive, asks how that argument is different from the position of a highly paid individual who receives a sizeable bonus, payment of which is deferred to enable them to take advantage of the lower tax rate that it will attract the following year, when the top rate of tax will be reduced by 5%.
In fact, adds Richard, this is a perfect example of the well-off being treated differently to the lower paid employee. The impact of the 20% increase in tax paid by the lower paid employee on his relatively small bonus is significantly higher than that on the 5% saving on the high earner award, even if the actual monetary amount is much smaller. Accordingly, he says, there must be a strong argument that in the interests of equity, companies should not differentiate in how they treat any discretionary awards, irrespective of the amount or the beneficiary.
Walter thanks Richard for his “interesting observations” and the meeting closes.
The dilemma
The first quarter of the year which often sees lurid headlines about the size and iniquity of “fat cat” bonuses. Following the announcement by the Chancellor of the Exchequer that he was reducing the top rate of income tax with effect from 5 April 2013 these headlines were given an added twist as a result of proposals by a number of firms proposing to defer payment of bonuses so as to take advantage of the forthcoming lower tax rates for high earners.
But is this outrage based more on the size of the proposed bonuses and levels of income of the beneficiaries, rather than the principle itself?
Options
- Since all parties cannot be satisfied, the firm should adhere to its existing policies, accepting that this may satisfy only a minority.
- Following the signal given by the board, it should delay the bonus payments for everyone.
- It should try and make specific allowance for individual employees.
- It should consult compliance as to the best course of action.
The Verdict
The most honest and fair thing to do would be to impose the same standard on all employees, which is consistent with the first option. The second option potentially attracts unwelcome publicity, reinforcing a perception of unfairness. The third option seems unwieldy and smacks of unfairness, and could attract attention from HMRC. The fourth option is likely to result in the same outcome as the first option.
Further reading