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With the setting in of Covid-19 pandemic, a number of businesses throughout the globe are experiencing the toughest test of all times. Some have already succumbed to the pressure of the pandemic and have either closed or suspended operations, with others following suit. Others have entered into furlough or pay cut arrangements with their workers as a way of avoiding a permanent shutdown. We also witnessed Chief Executives of some companies giving up part of their salaries as way of saving their businesses from inevitable collapse. Locally, some companies negotiated for a 50% pay cut with their employees for the month of April 2020 and further pay cuts are currently being negotiated. The question that begs an answer is whether such salary waivers or cuts would concurrently reduce the tax bill. This article addresses this matter and offers solutions for avoiding unexpected tax bill that may emanate from these arrangements.
An employee who waives his/her earnings or receives a pay cut should do so wisely. If a waiver or pay cut is made after the earnings are received or accrued to him/her, tax will remain payable. This is because gross income is recognised for income tax purposes when received by or accrued to a taxpayer, whichever occurs first. Any one of these occurring, the taxman will be entitled to his dues despite the income on which tax has become has not actual received by the taxpayer. An amount is received by the taxpayer when it is received by him or for his benefit. Simply put, this is when the amount has been deposited into his/her bank account or is at the person’s disposal. On the other hand, an amount accrues to a person when he/she becomes entitled to it notwithstanding the amount is yet to be received by him/her. In Lategan v CIR 1926 CPD 202 the court held that an amount accrues when the taxpayer’s right to claim the amount is not conditional on some other performance but only a time provision. In other words, the taxpayer should be able to sue for specific performance in a competent court in the event the debt remains unpaid. All conditions precedent should have been fulfilled and where income is conditional or contingent upon the happening of a future event an accrual is yet to be turned in money. Analogous to this, income that is pending the outcome of an event, for instance a collective bargaining or court outcome has the quality of income upon the happening of the future uncertain event i.e. the conclusion of the said event.
Salary accrues at the point it is earned and the tax on that income is paid at that time. Richardson J in the case Hadlee and Sydney Bridge Nominees Ltd v C IR (1991) 13 NZTC 8,116 said that “In relation to employment income the whole PAYE structure proceeds on the premise that income of that kind is derived by the employee concerned… [t]he statutory scheme in that regard does not allow for the possibility of diversion of that income by means of any kind of antecedent arrangement before its derivation by the employee”. Therefore, whilst wages may be earned on a day to day basis, employees are typically entitled to receive their salaries on their contractual payment dates which will be when the tax charge arises. This means that an employee should not waive his/her salary or take pay a cut after the contractual payment date if he/she hopes to avoid tax on such salary. If an employee’s contractual payment date is the 28th of each month, any agreement to waive any part of the current month’s salary should be made by the 27th. Our view is in agreement with the Roman Dutch law doctrine of assignment of income which postulates that income can only be ceded or waived before it accrues. Accordingly, any reinvestment, accumulation or capitalisation of amount has no effect of avoiding tax liability on amount that has already accrued to a person prior to the happening of any of such events. In other words, a waiver of salary or pay cut that occurs after the amount has been received or accrued has no effect of setting aside the tax liability legally due. The employer should account for tax on such amount notwithstanding the subsequent assignment by an employee of the income to the employer.
A bonus or commission is deemed to accrue to an employee, when declared or paid whichever is the earlier. An employee who entertains the hope of avoiding tax on such bonus or commission should waive or assign it before such a bonus or commission has been declared. Contractual bonuses may (depending on how they are calculated) be determined by reference to a period, such as a company’s financial year. A detailed analysis of the terms of the bonus arrangement will always be required.
In conclusion one cannot waive his/her salary or bonus after it has been received or accrued to him/her without incurring a charge to employment tax (PAYE). It is not only important for one to make the right choice regarding the waiver date but to also support this decision with appropriate documentation. This because our tax law places the burden of proof on the taxpayer without which tax liability could still arise. Documentation is not only important for purposes of covering the tax issues but also forms the basis the individuals are waiving their entitlement and when this arrangement will end. A pay cut should be supported by a new letter of employment. Going forward employees and their masters should take care when structuring these arrangements in order to avoid the unwanted tax bill on a legally implemented scheme necessary for purposes of saving the business from collapse.