Joe Brough outlines the conditions that must be met for a company to secure a corporation tax deduction for directors’ accrued bonuses and the associated PAYE implications.
It is common for an element of a director’s salary to be contingent on targets being met, which then results in them becoming entitled to be paid a bonus. Where a bonus is contingent on the profits made by the company, it may be some time after the year end until it can be determined whether it will be paid and, if so, how much.
The ‘right’ time
Where this is the case, the question arises as to when the company will receive corporation tax relief on the bonus and when PAYE should be applied. In certain circumstances, a company will be able to claim a deduction in an earlier tax year to that in which the payment is reported under PAYE. However, without careful consideration the opposite can also be equally true.
The use of director’s bonuses will not generally result in tax savings for director shareholders in an owner-managed business. The usual rules on ‘salary vs dividends’ will continue to apply, as a bonus is the same as a salary in respect of tax and National Insurance contributions (NICs) liabilities. The tax efficiency of a director’s total remuneration package is outside the scope of this article.
Corporation tax relief
For a bonus to be correctly accrued within a company’s year-end accounts, there must be an obligation for the company to pay the bonus at the year end. This obligation can result from the directors documenting their intention to pay a bonus prior to the year end, which is then voted on by the shareholders at the AGM or through past conduct. If the company has a history of paying bonuses, this can be indicative of a constructive obligation that it will continue to do so.
Where a bonus is included in the company accounts, CTA 2009, s 1288 allows a deduction for corporation tax, but only if it has been paid within nine months of the period end.
If the bonus has not been paid within nine months, a deduction is available in the period in which it is paid. As well as the gross bonus, an accrual can be made (and an associated corporation tax deduction claimed for) any secondary class 1 NICs due on the payment.
Practitioners may encounter situations where a bonus has been provided within the accounts, but which at the time of filing with HMRC remains unpaid. In such circumstances, HMRC states (in its Business Income Manual at BIM47140) that if the bonus is unpaid at the time of filing, a corporation tax deduction is not allowable. However, an amended return can be made (subject to filing deadlines) if payment is subsequently made before the end of the nine-month period.
Operating PAYE
Under ITEPA 2003, s 18, a payment to a director is treated as being ‘received’ by them for PAYE purposes on the earliest of the following:
Rule 1: When a payment of earnings is actually made or when a payment on account of earnings is made.
Rule 2: The time when a person becomes entitled to payment of earnings or a payment on account of earnings.
Rule 3a: The date when earnings are credited in the company’s accounts or records.
Rule 3b: Where the amount of the earnings is determined before the end of the period to which they relate, the date that period ends.
Rule 3c: Where the amount of the earnings is determined after the end of the period to which they relate, the date the amount is determined.
For non-director employees, only the first two rules are applicable, with rules 3a, 3b and 3c applicable to directors only.
Example: Timing of bonus payment
On 15 March 2023, in anticipation of record profits, the directors of Ezzy Ltd decide that a bonus pool of £50,000 will be split amongst the five directors for the year ended 31 March 2023. Each director’s entitlement will be based on the profitability in their respective service division.
At the AGM on 10 June 2023, each director has their bonus entitlement finalised, with payment to be made on 31 August 2023, on the condition that the director is still working for the company as at 31 July 2023.
For corporation tax purposes, a deduction for the bonus can be made in the year to 31 March 2023. At this time, the company had an obligation to pay the bonus at the year end, which could be reliably measured, with payment being made within nine months of the year end.
For PAYE purposes, the earliest date that the bonus earnings are treated as being paid is 10 June 2023 under rule 3c. This was the date of the AGM when the earnings were determined.
When applying the other rules, actual payment under rule 1 was made on 31 August 2023. Entitlement to the bonus under rule 2 arose on 31 July 2023, when all conditions precedent to the director becoming legally entitled to the payment were met. The company’s accounts were not updated until after the AGM (rule 3a), with each director’s final bonus amount not having been determined until after the company year end (rule 3b).
Application to salary only
As a bonus is subject to income tax and NICs this may not be preferable to all directors who, for their own tax efficiency, may not wish to receive a bonus. In these circumstances, it may be agreeable by the employer that instead of a bonus being paid through PAYE, the company may make an additional pension contribution on their behalf.
The ‘optional remuneration agreements’ applicable from April 2017 exempt employer contributions to registered pension schemes. Where a successful sacrifice is met, the conditions for which are outside of the scope of this article, the employer pension contributions are not taxable on the employee.
If a pension contribution is made instead of a bonus, the general rule for corporation tax purposes is that the deduction will be allowable against profits in the year in which the payment is made. Therefore, if a provision is made within the company accounts which is paid post-year end, this must be added back within the corporation tax computation in the year of accrual and deducted in the year of payment.
Directors’ loan accounts
As stated at the beginning of this article, accruing for a director’s bonus in an owner-managed business will not alter the tax efficiency of the ‘salary vs dividend’ strategy. However, there may be commercial considerations other than tax, which may make the payment worthwhile.
In a close company, where there is a loan to a participator who is also a director, a tax charge (under CTA 2010, s 455) may arise. In these circumstances, there may be insufficient distributable reserves to clear the outstanding loan via a dividend, or maybe the other shareholders do not wish to receive an additional dividend to do so.
A bonus paid within the nine months following the period end will satisfy the repayment condition for relief from CTA 2010, s 455 tax. As a payment of earnings, the repayment is not subject to the ‘bed and breakfasting’ anti-avoidance rules, by virtue of CTA 2010, s 464C(6).
If the bonus is provided in the accounts, the company will bring forward the tax deductibility of the bonus to the earliest opportunity and obtain tax relief earlier than would otherwise be the case. This could provide a cashflow benefit to the company; however, the timing of PAYE operation must still be considered in accordance with the above rules.
Practical tip
By correctly accounting for director bonuses, this can allow a company to obtain a corporation tax deduction against the profits to which they relate. However, care must be taken to ensure that the documentation is all in order and the PAYE is accounted for in the correct period.
