INCOME TAX FREE BONUSES
Bonuses paid to employees of companies controlled by an EOT benefit from an income tax (but not national insurance) exemption.
What are the conditions for the income tax relief?
The key requirements for income tax relief are:
- The employer company must be a trading company or a member of a trading group.
- A controlling interest in the company or, in a group of companies, the principal company in the group, must be held by an EOT, for at least twelve months.
- Provisions very similar to the equality requirement for the CGT exemption also apply to the income tax exemption.
- The company should not have more than a ratio of 2/5 for directors (plus any employees related to them) to employees and directors in total. (Please see the worked example below.)
- There is a maximum limit of £3,600 income tax free bonus per employee per tax year
- The payment must not consist of normal salary, must not be made by a service company and must be made under an arrangement under which:
- all employees of the company, or, where there is a group, any group company must be eligible to participate in any award (although employees with continuous service of less than 12 months can be excluded); and
- all employees participating in the arrangement must do so on equal terms (although awards can be determined by reference to pay, length of service or hours worked).
Example of the 2/5 ratio in operation: income tax free bonuses
A company has 3 people who are directors and 9 people who are either employees or directors. On the face of it, the ratio will be 3/9 which would satisfy this ratio requirement. If, however, one of the 9 is, for example, the son of one of the directors, he will be counted in with the directors as a relative. The ratio will become 4/9 which will not satisfy the requirement and it will not be possible to pay income tax free bonuses.
This is a complicated aspect and specific advice may be required in individual circumstances.
Our guide to becoming an employee-owned company compares trust-based, individual and hybrid employee ownership.