Over the past four weeks, we have examined salaries, dividends, pension contributions and directors’ loan accounts as methods of extracting profits from an owner-managed business.
This week, we turn to another commonly used remuneration tool: bonuses.
Bonuses can provide flexibility, reward performance and allow a company to remunerate particular directors or employees without permanently increasing their salaries. However, bonuses are generally subject to Income Tax and National Insurance contributions (“NICs”). Their tax efficiency should therefore be assessed as part of the company’s wider remuneration strategy.
In this article, we consider how bonuses are taxed, the Corporation Tax relief potentially available to the company, the relevant timing rules and the circumstances in which a bonus may be appropriate.
The rates and thresholds referred to below are those applying for the 2026/27 tax year. The Income Tax rates stated apply to taxpayers in England, Wales and Northern Ireland; different rates and bands apply to Scottish taxpayers.
A bonus is an additional payment made by a company to an employee or director, usually in recognition of performance, profitability or a particular achievement.
Unlike a dividend, a bonus represents remuneration for services provided to the business. It must normally be processed through payroll and is subject to PAYE and NICs.
Section 62 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA 2003”) defines employment earnings broadly and includes salaries, wages, fees, gratuities and other profits or benefits arising from employment. Cash bonuses fall within this definition and are therefore taxable as employment income.
Bonuses may be paid:
For owner-managed businesses, bonuses can offer a flexible way to reward directors and employees without committing the company to a permanent increase in fixed salary costs.
A properly structured bonus can provide a direct link between remuneration and performance. It allows a company to reward directors and employees who have contributed to its success without permanently increasing their basic salary.
A genuinely discretionary bonus may be awarded in a profitable year and reduced or withheld where performance or cash flow is weaker. However, employment contracts, established practices and the way in which discretion has previously been exercised should be reviewed before changing or withdrawing a bonus arrangement.
A bonus paid for genuine services provided to the business will normally be deductible when calculating the company’s taxable trading profits. Associated employer NICs will also generally be deductible.
Unlike dividends, which must be paid in accordance with the rights attached to the relevant shares, bonuses may be paid to particular directors or employees based on their respective roles and contributions.
Section 54 of the Corporation Tax Act 2009 (“CTA 2009”) provides that expenditure is not deductible unless it is incurred wholly and exclusively for the purposes of the company’s trade.
A bonus paid as genuine remuneration for services provided to the business will normally satisfy this requirement. The company should nevertheless be able to demonstrate the commercial basis for the payment, particularly where the recipient is:
The fact that a bonus also produces a tax benefit does not, by itself, prevent a deduction. However, where the amount bears little relationship to the services provided, HMRC may argue that the payment was motivated by the recipient’s position as a shareholder or connected person rather than by the needs of the trade.
Companies should therefore document how the bonus was calculated and why it was commercially appropriate.
Sections 1288 and 1289 CTA 2009 impose an important timing restriction where remuneration has been accrued but remains unpaid.
If a company accrues a bonus in its accounts, it must normally pay the bonus within nine months after the end of the relevant accounting period to obtain the Corporation Tax deduction for that period.
If the bonus is paid after the nine-month deadline, the deduction is generally deferred until the accounting period in which payment takes place.
For example, if a company with a 31 December 2026 year-end accrues a director’s bonus in its accounts for that year, the bonus would generally need to be paid by 30 September 2027 for the deduction to remain available in the accounting period ended 31 December 2026.
It is therefore important that a company does not merely record a bonus in its accounts. The bonus must also be properly authorised, processed through payroll and paid within the applicable deadline.
Bonuses are taxed as employment income through PAYE. For taxpayers in England, Wales and Northern Ireland, the principal 2026/27 Income Tax rates on employment income are:
The amount of tax payable will depend on the recipient’s total taxable income, available personal allowance and tax code.
For most employees in 2026/27, primary Class 1 NICs are charged at:
For 2026/27, employer Class 1 NICs are generally charged at 15% on earnings above the secondary threshold of £5,000.
Employer NIC represents an additional cost to the company over and above the gross bonus. The precise liability will depend on the recipient’s existing earnings, the applicable NIC category and whether any relief or allowance is available.
Eligible employers may be able to offset some or all of their employer NIC liability through the Employment Allowance. However, companies with only one employee who is also a director will not generally qualify.
Assume that:
The approximate position would be:
This example is necessarily simplified. The actual Corporation Tax benefit may differ depending on the company’s taxable profits, its associated companies and whether it falls within the marginal-relief band.
Companies with taxable profits between £50,000 and £250,000 may benefit from marginal relief, producing a gradual transition between the 19% small-profits rate and the 25% main rate. The marginal rate of Corporation Tax on profits within part of this band can be 26.5%. The £50,000 and £250,000 limits are reduced where the company has associated companies and are adjusted for short accounting periods.
For owner-managed companies, the choice between bonuses and dividends is a central part of remuneration planning.
For 2026/27, dividend income above the available dividend allowance is generally taxed at:
Although dividends are paid from profits that have already been subject to Corporation Tax, the absence of NICs means they may still be more tax-efficient than bonuses in many circumstances.
However, the comparison should be based on the combined company and individual tax cost rather than solely on the tax rate paid by the recipient.
A bonus may be appropriate where:
Bonuses are not automatically preferable in these circumstances. The company’s cash flow, the recipient’s marginal tax rate and the employer NIC cost must all be considered.
The timing of a bonus can affect both the company’s Corporation Tax position and the recipient’s personal tax liability.
An accrued bonus must normally be paid within nine months after the end of the relevant accounting period if the company is to obtain the deduction for that period.
For most employees, a cash bonus is taxed when it is received or when the employee becomes entitled to receive it.
Special timing rules apply to directors under section 18 ITEPA 2003. A director’s earnings may be treated as received at the earliest of several statutory points, including:
Consequently, postponing the physical transfer of money until after 5 April will not necessarily defer the Income Tax and PAYE liability. The date on which the bonus is authorised, determined or credited must also be considered.
Where an individual’s adjusted net income exceeds £100,000, their personal allowance is withdrawn by £1 for every £2 of income above that threshold.
The personal allowance is fully withdrawn once adjusted net income reaches £125,140. This produces an effective 60% Income Tax rate on affected non-savings income between £100,000 and £125,140, before taking NICs into account.
A director considering a bonus should therefore assess whether it would move their income into this band. In some cases, an employer pension contribution or deferral of the bonus may produce a better result, subject to the applicable rules and allowances.
Owner-managed businesses frequently employ family members, and a family member may legitimately receive a salary or bonus for work performed.
The remuneration must, however, be commercially justifiable. Relevant factors include:
A substantial bonus paid to a family member who performs limited or undocumented duties may be challenged on the basis that it was not incurred wholly and exclusively for the purposes of the trade.
Companies should retain:
Cash bonuses must normally be processed through payroll and are subject to PAYE and Class 1 NICs.
The treatment of a non-cash reward depends on its nature. Some benefits may be taxable as benefits in kind and reportable through payroll or on form P11D, with employer Class 1A NIC potentially payable.
Other rewards, including certain vouchers and readily convertible assets, may instead be subject to PAYE and Class 1 NICs. The treatment should therefore be checked before the reward is provided.
For qualifying companies and employees, tax-advantaged share schemes such as Enterprise Management Incentives (“EMI”) may offer an alternative to a cash bonus.
Subject to the relevant conditions, an EMI option can potentially be granted and exercised without an immediate Income Tax or NIC charge. Capital Gains Tax may then apply when the shares are sold.
Shares acquired through a qualifying EMI option may also qualify for Business Asset Disposal Relief where the relevant conditions are satisfied. For EMI shares, the applicable two-year qualifying period can generally run from the date on which the option was granted rather than from the date of exercise. For qualifying disposals made from 6 April 2026, the Business Asset Disposal Relief rate is 18%.
EMI schemes are subject to detailed company, employee, valuation and procedural requirements and require specialist advice.
A bonus payment to a director should be properly authorised in accordance with the company’s articles of association, any shareholders’ agreement and the director’s service contract.
Directors must comply with their statutory duties under the Companies Act 2006, including:
Where a director participates in the decision to award themselves a bonus, any conflict must be properly managed and the decision documented.
If the company is insolvent or insolvency is probable, the directors must also take account of creditors’ interests. A bonus that prejudices creditors or cannot be commercially justified may expose the directors to challenge.
Where there are minority shareholders, excessive remuneration paid to a director-shareholder may also give rise to allegations of unfairly prejudicial conduct under section 994 of the Companies Act 2006.
Payments made on or around the termination of a director’s appointment should be considered carefully to determine whether they constitute remuneration, contractual compensation or a payment for loss of office requiring shareholder approval under sections 217 to 221 of the Companies Act 2006.
A company should determine whether a bonus is contractual or discretionary.
Even where a scheme is described as discretionary, the employer’s discretion should be exercised rationally, in good faith and consistently with the employment contract. The company should also consider:
Clear written bonus terms can significantly reduce the risk of disputes.
Common errors include:
Tax efficiency is important, but it should not be the sole reason for paying a bonus.
The company should also consider:
A well-designed bonus arrangement should balance tax efficiency with commercial objectives, employee motivation and legal compliance.
Bonus planning involves the interaction of Corporation Tax, Income Tax, NICs, employment law and company law.
The most appropriate approach will depend on matters including:
Before implementing or changing a bonus arrangement, the company should obtain appropriate tax and legal advice and ensure that the payment is correctly authorised, documented and processed.
Bonuses remain a valuable and flexible part of the profit-extraction toolkit for owner-managed businesses. They can provide Corporation Tax relief, reward particular individuals and allow remuneration to be adjusted according to performance and profitability.
However, the combined burden of Income Tax and employee and employer NICs means that bonuses are not necessarily the most tax-efficient method of extracting profits when considered in isolation.
Their greatest value often lies in forming part of a wider remuneration strategy alongside salary, dividends, employer pension contributions and other appropriate arrangements.
Business owners should pay particular attention to:
Next week, we will examine benefits in kind as another method of rewarding directors and employees. We will consider how commonly provided benefits are taxed, the reporting and National Insurance requirements, and which exemptions can make certain benefits a tax-efficient part of a wider remuneration package.