Row erupts over bid by taxman to target retainers paid to graduates

Published on Saturday 28 March 2009 16:13

AROW has broken out over whether small retainer payments paid to trainee lawyers, management consultants and other professionals hit by the credit crunch should be taxed, writes Teresa Hunter.

Thousands of young graduates who had been recruited and given starting dates for jobs are being asked to delay their first day at work for six months or a year by leading firms of lawyers and other businesses.

In some cases they are being offered a small sum of money "to go away" for a while, of typically 2,500 for six months or 5,000 for a year. The largest payments are being made by law firm Norton Rose, which is paying up to 10,000 for a year.

But tax consultants are at loggerheads with HM Revenue & Customs over whether these payments are taxable. Many hit will already have earnings from part-time work undertaken to fund their studies. Making retainers taxable will have a big impact on their ability to survive this enforced time-off.

HMRC is itself confused over the justification for taxing these payments. However, leading tax experts say they should not be taxed and point to tax law to back up their argument.

Mike Warburton, head of tax at Grant Thornton, said: "We are in unknown territory here, because we have never seen payments of this kind before. But we must be careful because this is an awful time for these young people, and could have a demoralising impact on their attitude to work for the rest of their lives. I firmly believe there are plenty of grounds to suspect that these payments should not be taxed."

John Whiting, a tax partner at PWC, added: "Income tax is designed for earned income. This income has not been earned, and the harsh reality is these jobs may never actually materialise. So how can they be classed as a payment from an employer?"

HMRC offered several explanations of why the payments should be taxed, before finally conceding there may be circumstances where the payments are tax-free.

Its first response was that the income would be taxed in the same way as payments made under restrictive covenants, whereby an employee receives a payment to agree not to carry out certain activities. However, these graduates are not being asked to sign any restrictive covenant-style contract.

Next HMRC said payments would be taxed if it could be established they were earnings, but these are not payments for earned work.

Next it argued payments would be taxed as if they were employment-related benefits.

Finally a spokesman conceded that some may not be taxed, depending on when in the tax year the payments were made.

He said: "It is hard to comment with any degree of certainty when the facts about terms and timing of payments are unclear. For example, if the payments were made in the same tax year as the employment started, then it is likely that they would fall within the rules on employment-related benefits. But this would not be the case if they were made in a tax year prior to commencement of the employment."

Whiting believes the payments are more akin to redundancy lump sums, which are tax-free up to 30,000. He said: "With redundancy, there is a clear expectation of a job and related earnings. If someone loses that job and those earnings and is paid compensation for the loss, it is tax-free up to 30,000."

Warburton cites previous case law on sporting signing-up fees. In the 1960s there were a number of cases, notably Jarrold (HMIT) v Boustead (1964), where footballers were paid compensation for giving up their, at that time, prestigious amateur status to become professional footballers. It was decided that payments for giving something up, though made by a future employer, were not payments made in the course of their employment and therefore should not be taxed.

Warburton added: "It seems to me that the tax commissioners were quite entitled to find that it was a capital sum in compensation. The remuneration for services was an entirely different thing."

Norton Rose says it is sitting down with each of its trainees to attempt to assess whether in his or her circumstances the payments should be taxed or not.

Graduate recruitment manager Karen Potts said: "It is a very complex area and may depend on a number of factors, including what they do with their time off. If it can count toward training, because they go abroad to learn a language, for example, then we understand it can also be tax-free."