Waivers of remuneration or dividends – beware the tax sting

Almost every business, whether it is a multinational, an incorporated sole trader or a family company will be looking at how their organisation can ride out the COVID-19 storm. Maintaining cash resources to keep the business running will be a key priority in addition to adjusting to new ways of working both currently and going forward.

Many executives and other staff members might have volunteered to forgo bonuses or take a reduction in salary and will be making significant financial sacrifices to assist their employer’s business. Those taking these steps might think there could not possibly be a tax problem in doing so, they are simply not receiving those payments. However, it is essential that proper consideration is given to the timing of any such waiver of remuneration as the employee, in doing their bit to assist the business, could be hit with an unexpected tax bill.

Waiver of salary or bonuses

Any waiver of salary or bonuses must be done before it is treated as received for income tax purposes. If the salary or bonus is given up after it is treated as received for tax purposes then the employee remains taxable on the remuneration given up. Income tax and national insurance contributions (NICs) would still be payable. If an employer fails to pay an employee’s salary due to cash flow problems there is of course no tax charge.

Most employees are paid monthly in arrears and so they can waive their salary for any particular month up to the day before payment is due. But they cannot waive salary for a month where they have already been paid. A review of the individual’s employment contract would be advisable particularly where there is a different payment pattern and especially in relation to bonus entitlements to check the date on which payments are due to be paid.

For example, an employee who is paid monthly on the 25^th day of the month agrees on 20 June 2020 that they will take a 25% pay cut for the three months commencing 1 May 2020. Tax and NICs will only be due on the reduced portion of the salary for June and July but will still be due for the full salary paid at the end of May.

An employee may wish to repay salary or bonuses which they have received but it is not possible to reclaim the tax and NICs which were deducted from that payment.

HMRC’s hands are tied in this regard. Without changes to the legislation they must collect the tax due even though the employee is being taxed on payments they did not actually receive because they had agreed to waive it.

Waiver of dividends

Owner managers may well be looking at taking similar steps, deciding to waive a portion of their salary or bonus and together with other shareholders might perhaps be considering waiving rights to dividends in order to retain cash in the business at the current time. Again this must be done in the correct order or a tax bill could arise without the corresponding receipt of the dividends to pay it.

A formal waiver needs to be executed by the shareholder(s) and provided to the company before the right to receive a dividend arises. For a British company, in the case of final dividends this must therefore be done before they are formally declared and approved by the shareholders at general meeting. For interim dividends, the waiver must be in place before the dividends are paid.

With businesses and their staff doing everything they can to ensure a stable financial future it is vital not to overlook the potential tax traps that can arise.