Year-end bonus timing across the director/shareholder boundary
Marlow Trading Ltd is a small owner-managed company. Its only two shareholders are also its only directors: Priya holds 60% and Daniel 40%. In the year to 31 March the company expects trading profits before directors' remuneration of £118,000. Priya already draws a salary of £12,570 and Daniel a salary of £8,000; both are paid monthly. The company has retained profits of £95,000 and no other income. The directors want to extract a further £40,000 in total before the year end and are arguing about whether to take it as a bonus or as a dividend. Daniel has £6,000 of unused basic-rate band after his salary and no other income; Priya's salary uses her personal allowance in full. The company pays corporation tax at the small profits rate. Employer's NIC is 13.8% above the secondary threshold and employee NIC 12% within the main band.
1. Explain, with figures, why the choice between bonus and dividend is not a single company-wide decision but a decision that must be made director by director.
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The tax cost of extraction depends on whose income is increased and by how much, so the analysis differs for Priya and Daniel.
Bonus route. A bonus is deductible for corporation tax (saving 19%), but it triggers employer's NIC of 13.8% on the excess above the secondary threshold, and employee NIC of 12% in the main band plus income tax at the marginal rate. The employer's NIC is a real cost to the company that reduces the cash available to both shareholders.
Dividend route. Dividends are not deductible, so no corporation tax relief, but no NIC arises. The dividend allowance and the 8.75%/33.75% rates apply, and - critically - the tax rate depends on each recipient's remaining band.
Daniel has only £6,000 of basic-rate band left, so a large dividend to him would be taxed at 33.75%, whereas a modest one stays at 8.75%. Priya's position is different because her salary already uses her allowance. Any bonus allocated to Daniel also attracts employer's NIC that the company bears, effectively shared 60/40 between the shareholders but benefiting Daniel only. The correct approach is therefore to model each director's marginal rate separately and then check the total company-plus-shareholder cost, not to apply one rule to the £40,000 as a whole.
2. Daniel proposes taking his share as a £16,000 bonus (his 40% of £40,000). Identify the two specific figures an AAT candidate must calculate before accepting that proposal, and explain what each tells you.
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1. The gross-up for employer's NIC. A £16,000 bonus is not a £16,000 cost to the company. Employer's NIC at 13.8% applies to the bonus above the secondary threshold, so the company must pay the bonus plus 13.8% of the excess. If the intention is that Daniel receives £16,000 net of employer's NIC, the gross cost is higher: £16,000 × 1.138 ≈ £18,208 (subject to the threshold). The £2,208 difference is cash the company pays that neither director receives, and it reduces distributable profits available to Priya.
2. Daniel's marginal income tax and employee NIC. Daniel's salary is £8,000, so he has £4,570 of personal allowance unused. The first £4,570 of bonus is tax-free. The next £6,000 falls in his basic-rate band at 20%, and the remainder at 40%. Employee NIC at 12% applies across the main band. The combined marginal deduction on the top slice can exceed 50% once employer's NIC, employee NIC and 40% tax are added together.
Calculating both figures shows whether the £16,000 headline is really worth £16,000 to Daniel - usually it is not - and whether the company's total outlay is proportionate.
3. Recommend an approach that balances the directors' competing interests while remaining defensible, and state one compliance point that must be observed whichever route is chosen.
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Recommendation. Split the extraction: pay a modest bonus to Daniel only, sized to use his remaining personal allowance and basic-rate band (roughly £10,500–£12,000 gross), because his marginal rate is low there; take the balance as dividends in proportion to shareholdings (60/40) so that the dividend tax rates apply to each holder's own band. This uses Daniel's lower-rate capacity without pushing him into 40%, avoids employer's NIC on the whole £40,000, and keeps the dividend split consistent with the shares.
Compliance point. Whichever route is used, the payment must be properly authorised and documented. A bonus must be voted by the board, recorded in the minutes and processed through payroll with real-time information submitted by the payment date, with PAYE and NIC paid to HMRC by the 22nd of the following month (19th if paid by post). A dividend may only be paid out of distributable profits, must be supported by board minutes and a dividend voucher for each shareholder, and must reflect the shareholdings unless a valid different arrangement exists. Paying a dividend without distributable profits or without documentation is the classic error and can be recharacterised as salary by HMRC.