Are tax-free bonuses a good idea?

You are looking for some new ideas which would cut costs and boost sales in your business. But how can you incentivise your employees to develop ideas which could help you to achieve this? Partner Joanne Gibson explains.

Tax-free incentive
There is a special exemption that allows you to make a tax and NI free payment to employees for suggestions that you put into practice, and sometimes even when you don’t.

As you would expect there are several conditions to meet:
• You must have a suggestion scheme in place before an exempt payment can be made.
• The scheme must be open to all your employees or class of employees on the same terms.
• The suggestion could not reasonably have been expected to be put forward as part of the employee’s normal job.
• The suggestion is not made at a meeting held for the purpose of proposing suggestions.

Unsurprisingly, there are limits on the tax-free amount depending on the nature of the suggestion.

Encouragement awards
You can reward staff for a suggestion with intrinsic merit or showing special effort. The maximum amount you can pay is £25.

ABC Kitchens Ltd decides to run an encouragement award scheme which was framed around who could pick the best name for their new range. The winner gets £25 cash, which is exempt from income tax and NI.

However, if the reward exceeds the maximum, the excess is subject to income tax and NI.

Please note, you can use an encouragement award for suggestions that you don’t take forward, but which still deserve recognition for effort.

Financial benefit awards
There’s a much higher reward available if you take forward a suggestion from an employee that relates to an improvement in efficiency or effectiveness.

You must decide to adopt their idea and reasonably expect that this will result in a financial benefit to qualify for the exemption. The maximum that can be paid tax and NI free is £5,000.

However, you don’t have flexibility to pick an amount under £5,000. Strict rules are in place to calculate the reward to ensure that it is proportionate to the amount saved by the business.

The amount that can be paid tax free is limited to the greater of:
• 50% of the expected first-year financial benefit.
or
• 10% of the expected benefit over five years.

You must keep detailed records showing how projected savings were calculated in case HMRC asks questions about this.

EXAMPLE. Jane, a receptionist, suggests automating a manual invoicing system that saves the business an estimated £8,000 in its first year and £4,000 per year thereafter. 50% of the first-year benefit is £4,000, and 10% of the benefit over five years is £2,400. Therefore, the maximum amount that can be paid free from tax and NI is £4,000.

IN SUMMARY
You can incentivise employees to share their cost saving ideas by implementing a staff suggestion scheme. If you take their idea forward, you can reward them with a tax-free cash bonus worth up to £5,000. The maximum amount you can pay is based on a formula applied to the expected benefit to the business. You can also make tax-free encouragement awards for special effort and good ideas that you do/don’t implement, up to a maximum of £25.

Please do contact our team with any further questions you may have relating to this or similar scenarios.