Lee Sharpe looks at the issue of when bonuses should be paid and payroll obligations accounted for, with an eye to the recent increase in corporation tax rates.
From a tax perspective, there is a tension between wanting to get tax relief for salary payments and having to account to HMRC for PAYE and National Insurance Contributions (NICs). It is quite possible to trigger a PAYE obligation before the director or employee has actually taken the benefit of any net payment. Strictly, NICs may be triggered separately from PAYE.
In terms of overall tax efficiency, rising corporation tax rates and worsening dividend taxation mean that a substantial bonus or salary payment to a shareholder or director may prove more tax-efficient than the dividend alternative. The differences are only small so far, but given the direction in which tax policy has been moving over the last few years, there may be worse to come. And there can be non-tax reasons for preferring a bonus over a dividend.
How late a payment?
Under general accounting principles, one may accrue for a bonus or salary payment at the end of the accounting period. This might, for example, be because it has become customary to make a bonus payment at the end of the year, or because the efforts in the year drove the expectation of the bonus – very simply: “If you help to increase sales this year by £x, the business will pay a bonus.”
What a business cannot do is just decide in (say) May 2024 to accrue for a bonus in the December 2023 annual accounts just because it belatedly wants to reduce the 2023 profits and tax liability. But if the payment obligation had already existed at the end of December 2023, a provision in the 2023 accounts may pass muster.
In theory, one could make substantial provisions (accruals) to reduce the tax on business profits but without actually paying them for a significant period. But tax law has long required that any payment should be made no later than nine months after the end of the relevant accounting period and if it is paid later, it must be disallowed in the computations for the period of the accrual, then being deductible only once it is actually paid (ITTOIA 2005, s 36; CTA 2009, s 1288).
Example: Bonuses paid late in error
Late Ltd makes up its accounts to 31 December annually, and provides for year-end bonuses in its accounts but does not typically pay them out until June the following year. It duly provides £80,000 in its December 2023 accounts for bonuses for its director and employees.
Unfortunately, due to a software error, the 2023 bonus is not paid in June and this is not picked up until October 2024 (let’s just assume everyone was really, really busy). While it is physically paid to all entitled employees within a few business days of the error’s discovery, it is no longer deductible in the December 2023 tax computations, but may be allowed as a 2024 expense.
Triggering the PAYE or NICs obligations
For general earnings, the employer is obliged to operate PAYE at the time when the salary, etc., is ‘paid’. Unfortunately, this is not always the same as when physical payment is made. For ‘ordinary’ employees, PAYE income is to be treated as paid on the earlier of:
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when the payment is made; and
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when the person becomes entitled to payment.
Directors may be in a position to manipulate the timing and method of payment, so the rules for PAYE payments to them are even more stringent, being the earliest of the following (ITEPA 2003 ss 684, 686; 18):
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when the payment is made;
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when the person becomes entitled to payment;
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when relevant amounts are credited in the company’s accounts or records (whether or not there is any restriction on the right to draw the sums);
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if the amount of the income for a period is determined before the period ends, the time when the period ends; and
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if the amount of the income for a period is not determined until after the period has ended, the time when the amount is determined.
Looking again at Late Ltd, if it could be argued that the employees were entitled by custom to be paid their 2023 bonuses in June 2024, then PAYE should have been operated as if they had been paid in June 2024, not when they were actually paid, in October 2024 – as in (2) above.
For the director, it is likely that PAYE will be due even earlier than that: even if their bonus entitlement had not been established by the end of December 2023, as per (d) above, it is likely that the amount would have been fixed (as per (e) above) some time before it was actually paid, or even due to be paid.
NICs: ‘unreservedly’ made available
A key difference between NICs and PAYE is that earnings for NICs purposes are deemed to be paid only when they are put unreservedly at the disposal of the earner, as per Garforth v Newsmith Stainless Ltd (1978) 52 TC 522. The only reference I can now find to this specific phrase in HMRC’s entire NICs Manual is at NIM02200 for holiday pay, whereas NIM02005 simply states: “Liability arises at the time the earnings are paid” (NIM01002 admits only that “Liability for Class 1 NICs arises at the time the earnings are placed, unconditionally, at the employee’s disposal”, so we can expect to see that section disappear soon enough.)
Even so, the online 2023/24 booklet CWG 2 ‘Employer Further Guide to PAYE and National Insurance Contributions’ still includes at section 1.3 (separating the approach between PAYE and NICs):
“For National Insurance Contributions Purposes
The point of payment is that at which the earnings are placed unreservedly at the disposal of the employee.”
It follows that, in the above example, Late Ltd’s obligation to account for NICs on the 2023 bonuses will not be triggered until the bonuses are physically paid in October 2024.
Implications for the new corporation tax rates
We might want to maximise our deductions against profits being taxed at the main 25% or marginal 26.5% rates. Where a company’s chargeable period straddles the introduction of the new rate on 1 April 2023, for these purposes it is effectively split into two sub-periods, and apportioned.
It might be ‘nice’ if the deduction for year-end bonuses or similar were more weighted to the later sub-period, thereby potentially saving tax at significantly more than 19%. Alas, it seems such apportionment must be on a time basis (CTA 2010, s 1172; CTA 2009, s 52 specifically for trades).
However, HMRC does seem open to apportionment on a “just and reasonable basis”, such as for loss periods straddling the date of reform on 1 April 2017 (F(No 2)A 2017, Sch 4 and see HMRC’s Company Taxation Manual at CTM04880). Marshall Hus & Partners Ltd v Bolton [1980] 55 TC 539 is often cited as authority for this approach, but note the case found in favour of HMRC while trying to combat perceived anti-avoidance. HMRC’s own guidance accepts the ‘Hus approach’ in terms of apportioning across long periods of account (i.e., where the company’s financial statements span more than 12 months and must be split into two chargeable periods – see also HMRC’s guidance in the Company Taxation manual at CTM01405 and Business Income Manual at BIM81065).
Perhaps, rather than choose a long period of account and argue with HMRC over the applicability of the Hus approach to large bonus accruals in the later period, the directors might prefer to take a short period to 31 March 2023 and a ‘stub’ period chargeable only under the new rates. What may be accrued at 31 March 2023 may well not be the same as at the end of the stub period.
Conclusion
The same earnings can have different dates of deemed payment, whether considering PAYE, NICs on earnings or taxing business profits.
Unsurprisingly, HMRC wants PAYE to be triggered as soon as possible, while if payment is put off for too long, tax relief on profits may be postponed until a later period. It is important to take advice before making substantial bonus payments, or changing the business’ accounting date.
