The 2024 UK Corporate Governance Code: malus and clawback tax issues

The revised Code sets new expectations for malus and clawback provisions on executive bonuses – what are the employment tax considerations?

What are the employment tax considerations?

The Financial Reporting Council published the updated UK Corporate Governance Code on 22 January 2024. This applies to accounting periods beginning on or after 1 January 2025 for all companies with a premium listing on the London Stock Exchange. The new Code expects malus and clawback provisions to apply to directors’ bonuses delivered in cash or in shares. This article summarises when unexpected income tax charges can arise in relation to malus provisions, and what steps employers can take to maximise the likelihood that income tax relief will be available if bonuses are clawed back.

Code changes on remuneration

The Code now states that contracts and/or other agreements or documents which cover director remuneration should include malus and clawback provisions that would enable the company to recover and/or withhold sums or share awards, and specify the circumstances in which it would be appropriate to do so.

There is also now an expectation that companies describe their malus and clawback provisions in the annual report, including:

  • The circumstances in which malus and clawback could be used;
  • A description of the malus and clawback period and why it is appropriate; and
  • Whether malus and clawback provisions were invoked in the last reporting period (and, if so, why). 

Malus and clawback – what’s the difference and why does it matter?

Though they’re often used interchangeably, ‘malus’ and ‘clawback’ have different and distinct meanings.

A ‘malus’ provision is one that – should specified events occur – allows the remuneration committee to adjust an executive’s bonus downward before the award vests and is delivered (i.e. paid in cash or satisfied in shares).

In contrast, a ‘clawback’ provision lets the remuneration committee require an executive to repay cash, or return shares, which formed part or all of an award that has already vested and been delivered – again should a specified trigger event occur.

The different ways in which malus and clawback provisions work gives rise to different employment tax considerations that should be borne in mind when awards are being structured. 

Employment tax considerations for malus provisions

Generally, malus provisions are intended to operate before income tax charges, and payroll withholding obligations, arise on an award (i.e. the level of the award is reduced before it ‘vests’, so the executive is taxed only on the value received). Broadly, income tax charges and payroll withholding obligations arise on cash bonuses paid to directors on the earliest of when:

  • Payment is received;
  • A right to receive payment arises (i.e. the executive could then sue for payment);
  • Earnings are credited in the company’s accounts;
  • A period for which earnings are determined in advance ends (e.g. the end of a vesting period where the level of the payment is pre-determined); and
  • Earnings are determined for a period after it ends (e.g. when satisfaction of a performance condition, and the resultant bonus payment, is confirmed after the end of the performance period).

Different rules apply for awards over shares when, generally, income tax charges and payroll withholding obligations arise when the executive acquires a beneficial interest in the relevant shares.

To avoid an executive being taxed on an amount they do not receive, malus provisions should therefore be carefully structured to ensure that they operate, and effectively reduce the amount of the award for tax purposes, before a tax point arises.

Employment tax considerations for clawback provisions

In contrast to malus, clawback provisions always operate after the executive has been taxed on the relevant award. However, provided the clawback provision is carefully structured, any cash bonuses repaid should be treated as ‘negative taxable earnings’ – which should reduce the executive’s taxable employment income in that tax year.

Whether ‘negative taxable earnings’ also arise when shares are returned under a clawback arrangement depends on precisely how the award is structured, as well as how the clawback provision operates.

Whilst ‘negative taxable earnings’ can generate income tax relief, no relief from employee’s or employer’s NIC would be due in respect of any amounts clawed back.

What should remuneration committees consider?

When considering how the company will respond to publication of the updated UK Corporate Governance Code, the remuneration committee should think through what impact malus and clawback provisions, should they ever be operated, could have on the tax treatment of incentive awards under its plans. This includes considering whether:

  • Current malus provisions, if invoked, would effectively reduce the taxable amount prior to vesting of the award (and, if not, what steps could be taken to ensure that they do); and
  • Current clawback provisions should, if invoked, give rise to ‘negative taxable earnings’, so that income tax relief could be claimed for any taxed amounts returned (and, if not, whether any steps could be taken to increase the likelihood of such income tax relief being available).

These points should also be considered in relation to the structure of any new malus and clawback arrangements.

The potential availability of income tax relief for any amounts repaid under a clawback provision might also influence whether the clawback would operate on a gross bonus or net of tax basis, and how any relief for ‘negative taxable earnings’ might be factored in.

Where it does not appear that the tax impact of stand-alone malus and clawback provisions could be improved, alternative arrangements might give a better result (e.g. in effect, operating clawback on vested awards by imposing malus on an unvested award) and could be anticipated by award documentation in advance.

How KPMG can help

KPMG in the UK’s Reward team has extensive experience advising listed companies on the tax and commercial aspects of senior executive reward and incentive structures. Please contact the authors, or your usual KPMG in the UK contact, to talk through what malus and clawback provisions might mean for the employment tax treatment of your executive plans.

You can read more on the 2024 UK Corporate Governance Code at KPMG’s Board Leadership Centre.