Paying a Bonus and tax

Your accounting period is due to end soon and your fellow directors want to pay a bonus so the company can reduce its corporation tax bill. However, they don’t want to pay tax on it until the following year. Is this possible? Brona MacDougall advises on the timing and rules that you should be aware of.

Bonus v dividends
Dividends still represent the most tax-efficient method for taking income from your business. But there are circumstances where they can’t be paid or when it is not desirable to do so. For example, if your company is loss making or has external investors (shareholders) where the intention is to direct profits based on performance of the owner managers rather than all shareholders.

Timing a bonus
If you intend to pay a bonus you need to make sure that the administration is dealt with properly to ensure that your company obtains a corporation tax (CT) deduction for it at the earliest opportunity. The best time is shortly before the end of your company’s accounting year/period. This is because to obtain a tax deduction for the accounts to which the bonus relates there must be an obligation to pay it.

An obligation to pay a bonus exists at the accounts year/period-end date if you vote for it in principle before the accounting year end. The timing and method of payment can be sorted out later.
However, to qualify for a CT deduction for the accounting period to which a bonus relates, the actual bonus payment, e.g., the transfer of cash from the company to the director or a credit to their loan account, must be made within nine months of the end of the accounting period. If it isn’t then the deduction is delayed and allowed for in the accounting period in which the payment occurs.

The definition of `paid’
The definition of `paid’ is not simply when the cash is transferred to the director. The rules that apply to determine if the unpaid remuneration has been `paid’ within nine months of the year end for securing a corporation tax deduction are broadly the same rules as apply to determine whether a payment has been made for PAYE purposes (thereby triggering the PAYE liability). The date of payment is earliest of the dates determined the following rules.

Rule 1 – The time when the payment is made of or on account of earnings.

Rule 2 – The time when a person becomes entitled to a payment on account of the earnings.

Rule 3 – If the employee is a director and the earnings are from employment with the company of which the employee is a director (or was at any time during the accounting period), the earliest of:

1. The time when sums on account of the earnings are credited in the company’s accounts (whether or not there is any restriction on the right to draw the sums);
2. If the amount for a period is determined by the end of the period, when the period ends; and
3. If the amount of the earnings is not determined under after the end of the period, the time when the amount is determined.
If the employee is not a director, rule 3 does not apply and the payment date is the earlier of the dates determined by reference to rules 1 and 2.

The date on which PAYE is due may be earlier than the date on which the director actually receives the remuneration or bonus.

EXAMPLE
Smith Ltd’s current financial year ends on 31 March 2022. Its directors hold a board meeting on 30 March at which they approve a bonus for themselves equal to 20% of the company’s profits as shown when the accounts are finalised. Smith’s accounts should include a provisional expense to reflect the expected bonus. CT relief is permitted for this as long as the bonus is paid on or before 31 December 2022. The trigger date for PAYE purposes in this case is the date the amount of the bonus is determined. Smith’s 2022 accounts are finalised in July 2022. The directors are liable to tax on the bonus in 2022/23 and not 2021/22 when the bonus was approved in principle.

Watch for the increased NI
If you’re including a bonus in your company’s accounts which won’t be paid until on or after 6 April 2022, don’t forget to reflect the employers’ NI at the higher rate (15.05%) which will apply from that date.

IN SUMMARY
It is possible to vote a corporation tax deductible bonus but not trigger the PAYE until later. A decision by your company to pay a bonus doesn’t count as payment for PAYE purposes. The trigger date is when the amount of the bonus is determined or, if earlier, when the bonus is available for the directors to draw.