There are circumstances where an employer may need to consider making deductions from employee's salary—for instance, when training fees or a bonus payment need to be recovered from a departing employee, clinical equipment has been damaged, an employee has breached a contractual obligation, or a loan has not been repaid. The employer wants to recover the loss from the employee; but can they just delve into the employee's pay packet and take what they want? The answer surprises many employers.
Employees are generally entitled to receive a regular payment of wages in the amount set out in the contract of employment. However, there are situations in which an employer may need to withhold an employee's wages, or temporarily reduce the sum paid.
What counts as wages?
The definition of ‘wages’ is any sum payable to the employee in connection with their employment. This will include non-contractual bonuses, commission and statutory sick pay. Pension contributions, expenses and a loan to an employee are not considered wages—although a failure to provide these benefits when contractually obliged to may lead to the employee bringing a breach of contract claim.
It is unlawful for an employer to make deductions from an employee's wages unless the deduction is required or authorised by legislation, or the employee has already given written consent to the deduction being made.
When can employers make deductions from wages?
First of all—and perhaps most obviously—an employer can lawfully make deductions from wages in accordance with a statutory requirement to deduct and pay sums over to a public authority, such as to HMRC via the PAYE system.
Second, where the deduction arises as an ‘error of computation’, for example, where an automated pay roll system makes an error, deductions may be lawful to the extent that they are necessary to correct the error.
There are further exceptions in the legislation which allow the employer to make deductions in very specific circumstances, such as an overpayment of wages and expenses incurred by the employee.
More importantly, however, a deduction will not be unlawful if it has been ‘required or authorised to be made by virtue of … a relevant provision of the employee's contract’, or if ‘the employee has previously signified in writing his agreement or consent to the making of the deduction’. So, an employer wishing to make deductions will need to check the contract before making any proposed deduction. If the contract says nothing about making deductions from wages, then an employer will need to obtain prior written agreement from the employee to make the necessary deduction.
When can't employers make deductions?
Where the employee has not given written consent, whether in the contract of employment or otherwise, an employer should take care to avoid making deductions. Non-payment of an employee's wage on any one occasion will be classed as a deduction. A deduction will also arise from a late payment.
If an employer reduces one element of a wage but increases another element, leaving no overall reduction in pay, this could also be an unlawful deduction. For example, in the case of Pendragon plc v Nota, an employee was not paid £72.50 in overtime payment, but his pay for his contracted hours was increased. The Employment Appeal Tribunal held that each element of wages was isolated and the employee had suffered an unlawful deduction as a result.
In practice
Not paying an employee wages can lead to the employee bringing claims for breach of contract, constructive unfair dismissal, or a claim for recovery of the money that they are owed as an unlawful deduction of wages. The remedies an employment tribunal may award to an employee for unlawful deduction of wages include a declaration that the employer has made an unlawful deduction and an order to the employer to pay the sums deducted. The employee must bring the claim within 3 months of the deduction, or the final deduction in a series of deductions.
It is worth pointing out that with the introduction of The Deduction from Wages (Limitation) Regulations 2014, employees face a time limit for holiday pay claims. Now, when making a claim for backdated deductions from wages for holiday pay, a 2-year cap will be placed on all claims that are brought on or after 1st July 2015. This means that the period that the claim can cover will be limited to a maximum of 2 years. However, European Court of Justice decisions have sought to cast doubt on the lawfulness of this limit, so caution will still be needed when employers face claims of this nature.
During the period when the government's employment tribunal fees regime was in place (July 2013 until it's quashing by the Supreme Court in July 2017), claims for unpaid wages became less frequent since in many cases, the fee could be more than the amount in dispute. But since July 2017, employees have had no financial impediment to make a claim against an employer, and the figures suggest that claims numbers have rocketed generally.
Getting deductions wrong can have significant consequences. Employers must also be aware that if they attempt to recover payments due from workers in breach of the relevant legislation, they risk losing the right to recover the amount in question. In light of this, employers should review the written arrangements that they have in places where the need to make deductions from wages is likely to arise. This might include:
As a result, employers should be aware of their obligation to pay wages in accordance with the contract, as a disregard for paying wages correctly is very likely to lead to the employee resigning and claiming constructive dismissal. Employers should ensure that contracts of employment include a provision to allow for appropriate deduction of wages if required.
Paying bonuses
Bonuses are frequently used by employers as a tool to increase staff motivation. Bonus schemes can be a good way of remunerating employees, rewarding loyalty, or as a way of recognition for good performance. Employers intending to use bonus schemes would be well advised to carefully draft the structure of that scheme in order to avoid unintended consequences or challenges from dissatisfied employees.
Bonus schemes can either be contractual or discretionary. The way that an employer describes its bonus scheme is important. A contractual bonus scheme creates contractual obligations between the employer and the employee involved. This means that if the employer fails to pay the bonus in circumstances where it said it would pay a bonus, or pays a different amount to the amount it said it would, the employee could argue that they have suffered an unauthorised deduction from wages, or that their contract of employment has been breached.
Contractual bonus schemes should be carefully drafted, with employers identifying all the possible eventualities in advance. Forward planning is usually beneficial. As an example, in a case concerning the granting of share options in 2006, the High Court held that once the specific conditions in that employer's scheme rules had been met, the employer had no discretion not to award the share options to the employee, despite issues having arisen regarding the employee's misconduct.
Even where the bonus is described as discretionary, there are limits on how the employer exercises that discretion when dealing with a bonus. Employers are under a duty to exercise discretion honestly and in good faith; not to exercise discretion in an arbitrary, capricious or irrational way; and not to breach the implied term of trust and confidence.
In order to challenge a discretionary bonus payment, case law has determined that employees must usually establish either that the award is irrational or perverse, or that the payment is irrational when viewed in comparison to what other employees elsewhere within the organisation were paid.
Employers need to be aware of discrimination when allocating bonus payments, and should also take care to ensure that staff on maternity leave or on long-term sick leave are treated fairly and in line with the scheme rules.
Some employers use bonus clawback clauses to require employees to return bonuses that they have received if certain circumstances arise post payment. This is certainly becoming more common in the financial sector, where performance adjustment provisions may be required under the Remuneration Code. Repayment or clawback clauses are frequently used to seek repayment of bonuses in the event that the employee leaves their role within a certain period of time following payment of the bonus. In these circumstances, employees may argue that a repayment clause is unreasonable, either on the grounds that it is a penalty clause or a restraint of trade and therefore unenforceable. Again, careful drafting of the repayment clause is necessary in order to ensure that the clause is robust, enforceable and covers all of the possible circumstances.
Bonuses are taxed in the same way as any other income.
Conclusion
In conclusion, it is important that business owners are aware of the legality of deducting money from their employee's wages. Disregarding the law in this respect can result in expensive losses at the Employment Tribunal.