Bonus Payments for Employees UK

Bonus payments are one of the most sensitive and scrutinised elements of remuneration. They sit at the intersection of reward strategy, talent management and employment law. When they work, they drive performance and help attract and retain strong people. When they misfire, they generate grievances, discrimination risk and expensive litigation over what was “promised” or “fair”.

What this article is about
This article is a practical and detailed guide to bonus payments for UK employers, HR professionals and business owners. It explains the legal framework governing bonus pay, the difference between contractual and discretionary schemes, how to design and document lawful bonus structures, how to operate them in practice, and how tax and payroll rules apply. It focuses on the employer’s perspective: minimising risk, preserving flexibility and supporting a coherent reward strategy.

Bonus pay is not a legal requirement. Most UK employers are free to decide whether to offer bonuses at all, which employees are eligible and on what terms. At the same time, once a bonus scheme is introduced, the way it is communicated and operated can create contractual rights even where the employer intended to keep full discretion. The line between “discretionary” and “entitlement” is often thinner than it appears. Tribunals have shown a willingness to scrutinise bonus decisions that are irrational, discriminatory or inconsistent with written terms.

From an HR standpoint, bonus arrangements touch almost every aspect of the employment relationship. They influence recruitment messages, performance management frameworks, promotion decisions and redundancy choices. They can be a powerful tool for aligning individual behaviour with business goals. They can also embed inequality and disengagement if criteria are opaque or decisions are perceived as arbitrary. HR teams therefore need clarity on the legal guardrails so that reward policies support the wider people strategy rather than undermine it.

This article looks first at the legal framework that applies to bonus payments, including the distinction between contractual and discretionary bonuses and the impact of implied terms such as trust and confidence. It then considers how to design bonus schemes, from selecting the right model to drafting documentation and communicating eligibility and performance criteria. The next section looks at day-to-day operation of bonus schemes, including assessment of performance, handling absence and dealing with disputes and complaints. Finally, the article outlines the main tax and payroll rules affecting bonuses, including PAYE and NIC treatment.

Throughout, the focus is on practical risk management: how to preserve genuine discretion without creating hidden entitlements, how to avoid discrimination claims when allocating bonus pools, and how to future-proof schemes so that they remain workable when business conditions change. By the end, HR professionals and business owners should have a clear framework for reviewing existing bonus arrangements and designing new schemes that are both commercially effective and legally robust.

Section A: Legal framework for bonus payments

Bonus payments sit within a defined legal structure that governs when they become enforceable, how employers must exercise discretion and how tribunals interpret ambiguous or inconsistent bonus terms. HR teams and business owners need clear visibility of these rules because misunderstandings frequently lead to contractual disputes, unlawful deduction claims and allegations of discrimination. This section explains the foundations of bonus entitlements under UK law, the distinction between contractual and discretionary schemes, the limits that implied terms and statutory rights place on employer discretion and the key issues that arise when employment ends.

1. What is a bonus payment under UK law

A bonus payment is any additional remuneration paid to an employee beyond basic salary. Under the Employment Rights Act 1996, a bonus can constitute “wages” where the entitlement is contractual or where entitlement has crystallised under the terms of employment, for example because all qualifying conditions have been met and the amount is no longer subject to genuine discretion. A discretionary bonus that has not yet crystallised will not usually count as “wages” for the purpose of an unlawful deduction from wages claim.

Bonus payments can be structured as cash awards, profit-share arrangements, sales-based incentives or one-off lump sums. The form does not alter the underlying legal question: is the employee contractually entitled to the payment, or is the employer free to exercise discretion in awarding or withholding it? Where contractual entitlement exists, the employer has no legal ability to withdraw the bonus once qualifying criteria have been met.

Tribunals give considerable weight to the wording of contracts and scheme documents. Where a contract states that the employee “will receive” or “is entitled to” a bonus based on specific criteria, tribunals treat the bonus as contractual. Where the contract states that a bonus “may be paid” or is “at the company’s discretion”, tribunals recognise employer flexibility but will still examine whether discretion was exercised lawfully, rationally and consistently with the scheme rules.

2. Contractual bonuses vs discretionary bonuses

The distinction between contractual and discretionary bonuses is central to employer risk management. A contractual bonus creates a binding obligation to pay once the employee meets defined criteria. This obligation can arise even if the employer did not intend it, where scheme rules are unclear or where the bonus has been paid consistently over several years without qualification.

Custom and practice can in some cases create a contractual entitlement to a bonus, but tribunals apply a relatively high threshold. The practice must be clear, consistent, longstanding and known to employees so that they can reasonably view it as part of their contractual remuneration rather than a series of one-off discretionary gestures. Employers should review repeat bonus practices regularly to ensure they still reflect the intended legal position.

Contractual bonuses must be paid in full unless the scheme expressly allows pro-rating, adjustment or withholding in specified circumstances. Employers cannot rely on vague wording or after-the-fact reasoning to avoid payment. Any attempt to withdraw a contractual bonus is vulnerable to unlawful deduction claims and, in some cases, breach of contract or constructive dismissal claims.

Discretionary bonuses provide more flexibility. Employers may decide whether to award a bonus, how much to award and which employees should receive it. However, discretion is not absolute. Courts have established that discretion must be exercised in accordance with recognised principles: decisions must be rational, made in good faith and not arbitrary, perverse or discriminatory. Case law such as Clark v Nomura International plc and Horkulak v Cantor Fitzgerald International confirms that even where a scheme is discretionary, the employer can be liable if discretion is exercised irrationally or in bad faith.

Even within discretionary schemes, employers must ensure that scheme wording is clear and that communications do not create expectation-based rights. A poorly drafted “discretionary” clause may be overridden by consistent practice or by verbal assurances given during recruitment or performance reviews. HR teams should ensure that recruitment materials and appraisal discussions are aligned with the legal status of the scheme.

3. Implied terms and employer discretion

Bonus decisions are shaped not only by written terms but also by implied duties that govern how employers must act. The implied term of mutual trust and confidence requires employers not to behave in a way that destroys the relationship of trust between employer and employee. This limits the way bonus discretion can be used.

Court decisions, including Clark v Nomura International plc and Horkulak v Cantor Fitzgerald International, make clear that discretion must be exercised honestly, in good faith and in a way that is not irrational or capricious. An employer who refuses a bonus without providing any credible explanation, or who relies on reasons unrelated to eligible performance periods, risks a finding that discretion has been exercised unlawfully. Decisions influenced by irrelevant factors or personal animus are particularly vulnerable.

Implied terms also influence how employers evaluate performance for bonus purposes. If a manager applies criteria that depart significantly from those stated in the scheme, or introduces new eligibility requirements mid-cycle without consultation, the employer risks breaching implied duties. Decisions influenced by protected characteristics such as age, sex or disability may breach the Equality Act 2010 even where the bonus scheme is fully discretionary on paper. Employers must also avoid using discretionary decisions to punish whistleblowers, penalise employees for raising grievances or deter union activity, as this may give rise to separate statutory claims.

4. Bonus entitlement on termination of employment

Disputes over bonus entitlements often arise when employment ends. Whether an employee is entitled to a bonus during a notice period, on garden leave or when paid in lieu of notice depends on the terms of the scheme, the timing of the bonus cycle and the nature of the employee’s departure.

Many schemes require the employee to be “employed and not under notice” on the bonus payment date. If clearly drafted, these clauses are generally enforceable. However, ambiguity works against employers. Where wording is unclear, tribunals may interpret the clause in the employee’s favour, particularly where performance contributing to the bonus was completed before notice was served.

Bonus entitlement may also arise during garden leave unless expressly excluded. If an employee is placed on garden leave after completing the relevant performance period, and the scheme rules do not restrict entitlement during garden leave, the employee may retain the right to a bonus. Similarly, where an employer issues a payment in lieu of notice (PILON) and the contractual wording treats termination as taking effect immediately, bonus entitlement will depend on the precise terms of the bonus scheme and how it defines eligibility at the payment date. Tribunals are slow to imply bonus rights where scheme wording is clear, but they will also resist interpretations that are inconsistent with the commercial purpose of the scheme.

“Bad leaver” clauses, which deny bonuses to employees dismissed for misconduct or who resign to join a competitor, require precise drafting to be enforceable. Overly broad or vague exclusion clauses risk being struck down as unreasonable or as an unlawful penalty, particularly where they operate regardless of the seriousness of the conduct. Employers should ensure that such provisions are proportionate and clearly linked to legitimate business interests.

Section A summary

Section A has explained the legal foundations governing bonus payments, including what counts as wages for the purposes of the Employment Rights Act 1996, how contractual and discretionary bonuses differ and the limits imposed by implied terms and statutory rights. It has highlighted the circumstances in which custom and practice may create enforceable rights and the way courts assess employer discretion using principles drawn from leading bonus cases. It has also set out the key issues that arise when employment ends, such as the impact of notice periods, garden leave and PILON on bonus entitlement and the drafting requirements for bad leaver clauses. HR teams should ensure that bonus documentation is clear, consistent and regularly reviewed so the organisation does not unintentionally create entitlements or expose itself to avoidable claims.

Section B: Designing bonus schemes

Bonus schemes influence behaviour, shape performance culture and affect the employer’s exposure to legal risk. Designing a scheme involves more than deciding who should receive a bonus and in what circumstances. It requires deliberate structuring so that the criteria are clear, the mechanics are lawful and the documentation preserves the level of discretion the organisation intends to retain. A well-designed scheme reduces the risk of disputes, ensures compliance with equality and employment law and enables managers to make robust decisions that withstand scrutiny. This section sets out the main types of bonus schemes available to employers, how to determine eligibility and performance criteria and the drafting principles needed to create a legally defensible framework.

1. Types of bonus schemes

Bonus structures vary widely depending on industry, job role and organisational culture. HR teams need to select a model that aligns with what the business wants to achieve. Common models include performance bonuses, company-wide awards, sales incentives, sign-on bonuses, retention bonuses, event-based awards and profit-share schemes.

Performance bonuses are linked to individual, team or organisational objectives within a defined performance period. They reward measurable results and often form part of annual appraisal frameworks. Company-wide bonuses distribute awards to the entire workforce when collective financial or operational targets are met. These awards create alignment and encourage shared ownership of business outcomes.

Sales-based incentives form a substantial proportion of remuneration in some sectors. Commission structures must be drafted carefully to avoid inadvertent entitlement creation, particularly where commission becomes payable on revenue that the employee has already secured prior to termination. Sign-on bonuses are typically used to secure talent in competitive markets, while retention bonuses help maintain continuity during critical projects or organisational change. Profit-share arrangements distribute a portion of profits to employees in line with predetermined formulas and require careful tax and eligibility planning.

Each model carries different legal implications. For example, commission schemes often become contractual through custom and practice, whereas company-wide bonuses are easier to keep discretionary. HR professionals should ensure that the selected model supports broader business priorities and does not embed unintended obligations or conflict with other contractual terms.

2. Setting eligibility and performance criteria

Once the bonus model is chosen, the next step is defining eligibility and performance criteria. Eligibility should be set out clearly and must not conflict with statutory rights. Employers need to decide whether part-time staff, fixed-term workers or employees on leave are eligible. Discretion can be retained, but rules must still comply with the Part-time Workers Regulations, Fixed-term Employees Regulations and the Equality Act 2010.

Performance criteria can be objective, subjective or a combination of both. Objective criteria include sales numbers, margin targets, project milestones or financial metrics. Subjective criteria may include teamwork, leadership or customer satisfaction. While subjectivity can preserve managerial discretion, it increases the potential for grievances or discrimination allegations if decisions are not evidence-based. Subjective measures should therefore be accompanied by clear descriptors and documented examples so that decisions can be justified if challenged.

Measurement periods must be clear. If criteria change mid-cycle, employers must consider whether the change creates unfairness or breaches implied contractual duties. HR teams should ensure that line managers understand the criteria and apply them consistently. Inconsistency is a common trigger for disputes, particularly where bonuses are withheld despite employees having met previously communicated targets.

Pro-rating rules should also be explicit. Employers should state whether bonuses will be pro-rated for new starters, part-year service, reduced hours or parental leave. Without clear wording, tribunals may interpret ambiguity in favour of the employee. Pro-rating decisions must also be reviewed for equality implications, particularly where disability-related absence or family leave is involved.

3. Drafting bonus scheme documentation

Documentation is critical to controlling risk. Bonus schemes should be documented in employment contracts, standalone scheme rules or staff handbooks. The level of formality depends on how central the bonus is to the remuneration package and how flexible the employer wants to remain. Employers should be clear about the hierarchy of documents, making it explicit where the employment contract prevails and how the scheme rules are incorporated.

Where employers intend a scheme to be discretionary, the word “discretionary” alone is not sufficient. The rules must explain that discretion applies both to the decision to award a bonus and the amount paid. They should include explicit warnings that eligibility or performance criteria do not guarantee payment. Wording should also make clear whether previous awards create no entitlement to future bonuses and that participation in the scheme does not confer a right to continued employment.

If the employer wants to adjust or withdraw the scheme, the rules should contain a variation clause stating that the employer may amend, suspend or discontinue the scheme at any time. However, these clauses cannot be exercised in a way that breaches the implied duty of trust and confidence. In the case of contractual schemes, changes will usually require consultation and employee agreement, or a broader contractual variation exercise. Without careful handling, withdrawing or materially changing a long-running scheme may trigger breach of contract claims or constructive dismissal allegations.

Clarity is also required on timing, calculation methods, performance periods, treatment of leavers, disciplinary issues and clawback or malus provisions. Ambiguous wording is interpreted against the employer, particularly where significant sums are involved. Clawback and malus clauses should be clearly linked to legitimate business interests, such as misconduct, misstatement of results or regulatory failure, and should be proportionate so they are not treated as unenforceable penalties.

Employers should ensure that scheme rules are consistent with contractual terms. A mismatch between the contract and the scheme invites challenge. For example, if the contract describes the bonus as discretionary but the handbook sets guaranteed criteria, tribunals may treat the bonus as contractual or resolve the conflict against the employer. Consistent, coherent documentation and a clear statement of which document prevails reduce this risk.

4. Communication and transparency requirements

Effective communication supports legal defensibility. Even discretionary schemes should be communicated in a way that avoids creating unintended commitments. Employers should explain the purpose of the scheme, how eligibility works, what criteria will be assessed and when decisions will be made. Communications should reinforce that the scheme is subject to the terms of the written rules and, where relevant, that the employer retains discretion.

Transparency helps mitigate discrimination risk. Employees must understand how their performance was evaluated and why a particular bonus decision was reached. Where decisions are based on subjective criteria, managers should be trained to justify evaluations with evidence. A lack of explanation or inconsistent rationale is a common feature in successful bonus-related claims. Written rationales and calibration notes are particularly valuable if decisions are later scrutinised by a tribunal.

Record-keeping is essential. Employers should retain documentation showing how decisions were made, including assessment data, moderation notes and justification for award levels. This information is critical if employees raise grievances or bring tribunal claims and will often be requested in disclosure.

Finally, communications must not contradict written rules. Informal assurances given in meetings, performance reviews or recruitment discussions can undermine carefully drafted discretionary clauses. HR should brief managers on the importance of maintaining consistent messaging and avoiding statements that could reasonably be interpreted as promises of a particular level of bonus.

Section B summary

Section B has set out the practical and legal considerations involved in designing bonus schemes. HR teams must choose a model that supports organisational objectives, define clear eligibility and performance criteria and draft documentation that preserves the intended level of discretion while respecting contractual and statutory limits. Transparent communication, clear document hierarchies and consistent application reduce the likelihood of disputes and help build a defensible reward framework. By investing time in design and documentation, employers are better placed to operate bonus schemes that are both commercially effective and legally robust.

Section C: Operating bonus schemes lawfully

Once a bonus scheme has been designed and documented, employers face the practical challenge of operating it lawfully and consistently. This is where disputes commonly arise. Even the most well-drafted scheme becomes vulnerable if decisions are made inconsistently, if performance assessments lack evidence or if managers exercise discretion without understanding the legal limits. HR professionals must ensure that processes, timelines and governance structures are robust enough to support fair decision-making and withstand potential challenge. This section explains how employers should assess performance, when they can lawfully withhold or adjust a bonus, how bonus rules apply during periods of absence and how to manage disputes when employees challenge outcomes.

1. Assessing performance and making award decisions

Performance assessment is central to most bonus schemes. Employers must ensure that evaluation processes are fair, transparent and evidence-based. Decisions grounded in incomplete data or influenced by irrelevant factors risk breaching implied contractual duties and the Equality Act 2010. Employers must also ensure that assessments do not penalise employees for protected activities such as raising grievances, making protected disclosures or participating in trade union activities.

Where schemes use objective metrics, employers must document how those metrics were measured and confirm that employees were informed of targets at the start of the cycle. Mid-year changes to criteria should be communicated promptly and consistently. Failure to do so can render decisions unfair, especially if employees had no opportunity to adjust performance expectations.

Where schemes rely on subjective evaluation, the legal risk increases. Subjective assessments must be rooted in demonstrable evidence—such as customer feedback, leadership examples or project outcomes. HR teams should implement moderation processes to ensure consistency across managers and departments. Unmoderated manager-led assessments are particularly vulnerable to unconscious bias, leading to heightened discrimination risk. Employers should retain written justification for subjective decisions, as tribunals expect evidence supporting the rationale behind award levels.

Award decisions must also respect the principles of fairness applied to discretionary powers. Decisions cannot be arbitrary or based on ulterior motives. Employers should retain written justification for each decision, especially where awards differ significantly between employees with similar roles or performance levels. Clear records help defend decisions if challenged and demonstrate compliance with the implied duties governing discretion.

2. Withholding, adjusting or deferring bonuses

Employers often assume that discretionary schemes allow full freedom to withhold bonuses, but this assumption is legally risky. Withholding or reducing a bonus must align with scheme rules, contractual provisions and implied duties. If a scheme allows for withholding due to misconduct, underperformance or breach of policy, the wording must be precise. Vague references to “company interests” or “management discretion” will not justify arbitrary decisions.

Where employers want to adjust bonuses for disciplinary reasons, they must consider timing. If misconduct occurred after the performance period ended, withholding the bonus may be challenged unless the scheme expressly allows reductions for conduct issues unconnected to performance. Tribunals scrutinise whether the employer applied the rules fairly and proportionately.

Deferral and clawback clauses must be drafted clearly and reflect regulatory expectations where applicable, particularly in financial services. Clawback provisions should specify the events that trigger recovery, such as misconduct discovered after payment, material error in performance data or breach of post-termination restrictions. Courts will not enforce clawback clauses that are excessively broad or penal in nature. Employers should ensure such provisions are proportionate and linked to legitimate business interests.

Employers must also ensure that decisions to withhold or adjust bonuses comply with equality law. If an employee is disciplined for conduct related to a disability or for pregnancy-related issues, withholding a bonus may amount to discrimination. The Equality Act 2010 requires that any policy or practice that places employees with a particular protected characteristic at a disadvantage must be objectively justified. Blanket exclusions for sickness absence may be indirectly discriminatory unless supported by evidence and proportionate to a legitimate aim.

3. Bonus payments during absence

Bonus entitlement during periods of absence is a common source of complaints. Employers must consider statutory rights, discrimination law and the wording of the scheme.

Employees on maternity, adoption or shared parental leave retain entitlement to the proportion of a contractual bonus that relates to the period they were actively working before statutory leave began. Employers cannot lawfully withhold the element of the bonus that relates to normal work performed before leave. However, the compulsory maternity leave period (the first two weeks) must be excluded from bonus calculations because no work is permitted during this time. For the remainder of maternity or adoption leave, employers may pro-rate bonuses provided the calculation is consistent, proportionate and not discriminatory.

Shared Parental Leave (SPL) arrangements require separate consideration. Entitlement depends on the type and pattern of leave taken. Employers should ensure that pro-rating methods for SPL align with statutory obligations but do not necessarily need to mirror maternity or adoption leave calculations, provided the approach is fair and consistent.

Employees absent due to disability-related sickness must be treated carefully. An employer who withholds or reduces a bonus because the employee was off sick may breach the Equality Act 2010 if the absence relates to a disability. Employers can pro-rate bonuses fairly if the scheme is clear and consistently applied, but they must be able to show objective justification for any policy that disadvantages disabled employees.

For ordinary sickness absence or short-term non-disability absences, pro-rating may be permissible if the scheme wording supports it. Employers should document how absence is assessed and ensure managers understand the rules and equality implications.

4. Disputes and employee challenges

Employees frequently raise grievances where bonus outcomes appear inconsistent, poorly explained or unfair. How employers handle these disputes directly affects litigation risk. Clear processes help resolve concerns before they escalate.

When disputes arise, employers should provide a transparent explanation of the decision, including the evidence relied upon and how criteria were applied. Even in discretionary schemes, employers must demonstrate that decisions were rational and consistent. A refusal to give reasons can be viewed as evidence of arbitrariness or bad faith.

Grievances should be investigated by someone who was not involved in the original decision. Independent review supports fairness and helps correct mistakes without admitting liability. HR must ensure the reviewer has access to performance data, scheme rules and decision-making notes.

Where disputes cannot be resolved internally, claims are usually brought under the unlawful deduction from wages regime, breach of contract or, in some cases, discrimination or victimisation. Employers with robust processes, consistent documentation and clear scheme rules are better positioned to defend these claims.

Section C summary

Section C has outlined the practical requirements for operating bonus schemes lawfully. Employers must ensure performance assessments are fair and evidence-based, apply scheme rules consistently and treat absence and misconduct issues in accordance with statutory and contractual obligations. Transparent decision-making, careful record-keeping and timely communication significantly reduce the likelihood of disputes and enhance the defensibility of bonus outcomes.

Section D: Taxation and payroll compliance

Bonus payments form part of an employee’s taxable earnings and must be processed in accordance with PAYE and National Insurance contribution rules. Errors in tax treatment, late reporting or unclear documentation expose employers to HMRC penalties and employee disputes. Many organisations focus heavily on the bonus decision-making process but fail to give equal attention to payroll compliance, timing of payments and accounting obligations. This section sets out the tax treatment of bonuses, how salary sacrifice interacts with bonus planning, the reporting requirements that apply to employers and the considerations that arise when dealing with contractors or individuals operating through intermediaries.

1. Income tax and NIC treatment

Bonuses are treated as earnings under section 62 of the Income Tax (Earnings and Pensions) Act 2003. This means PAYE must be operated on the bonus when it is paid or when the employee becomes entitled to it, whichever occurs first under HMRC’s receipts basis rules. Employers should avoid situations where entitlement is created inadvertently through poorly drafted scheme rules, as this can trigger PAYE obligations before the organisation is ready to process payment.

Bonuses are also subject to Class 1 National Insurance contributions. Both employee and employer NICs apply, and the rate depends on the employee’s earnings in the relevant pay period. Where large bonuses are paid as a single lump sum, NIC liabilities can increase significantly because the amount is aggregated into one pay period rather than spread across the year.

Timing matters. Employers must process bonuses through payroll in the period in which they are paid, not backdate them or apply manual adjustments outside the payroll cycle. Late or incorrect reporting through Real Time Information (RTI) can lead to penalties and compliance scrutiny. Employers should ensure that bonus schemes are coordinated with payroll calendars so that entitlement does not arise before systems are ready to account for the payment correctly.

2. Bonus sacrifice and salary sacrifice arrangements

Salary sacrifice arrangements allow employees to exchange part of their cash salary or bonus for a non-cash benefit, such as increased pension contributions or childcare support. When structured correctly, salary sacrifice can reduce NIC costs for both employer and employee. However, HMRC’s rules require that the sacrifice is made before the employee becomes entitled to the bonus. Once entitlement exists, the employee cannot retrospectively sacrifice the payment for tax purposes.

For a salary or bonus sacrifice arrangement to be effective, HMRC expects the employment contract to be formally varied before the entitlement arises and for payroll records to reflect the revised (post-sacrifice) cash salary. If these conditions are not met, HMRC may treat the original, higher cash amount as taxable, regardless of any internal documentation stating that the bonus was sacrificed.

Employers must ensure that scheme documentation, contractual variation letters and payroll processes align. Where employers allow bonus sacrifice into pension contributions, this must be handled through the correct pension scheme mechanisms and reported accurately through payroll. Bonus sacrifice is not suitable for all employees or all schemes. Employers must consider the impact on statutory payments, student loan deductions and mortgage applications, as salary sacrifice can reduce headline earnings. Clear communication helps employees understand the financial and practical implications before opting into a sacrifice arrangement.

3. Reporting requirements

Payroll reporting obligations apply to all bonus payments processed through PAYE. Employers must include bonus amounts in RTI submissions for the relevant pay period. Any errors or omissions should be corrected promptly using the appropriate RTI correction mechanism, and employers should maintain internal controls to minimise reporting failures.

Where bonuses relate to benefits in kind or deferred awards, additional reporting may be required. For example, certain share-based bonus arrangements may trigger P11D obligations or require valuation for HMRC purposes. Employers must identify which elements of their reward package fall within PAYE and which require separate reporting so that nothing is omitted.

Record-keeping is essential. HMRC expects employers to retain evidence of how bonus amounts were calculated, the dates on which entitlement arose and the payroll entries associated with payment. This information is vital during compliance checks and may be requested several years after payment. Employers should also keep copies of scheme rules, board approvals and any documentation relating to salary sacrifice or deferral so they can demonstrate the basis on which tax and NIC decisions were made.

4. IR35, contractors and bonus-style payments

Bonus-style payments made to contractors must be approached with caution. True bonuses are unusual in contractor engagements, as contractors are typically paid for outputs rather than performance cycles. Where a business pays a contractor a lump sum for performance or retention reasons, HMRC may view this as evidence that the contractor is functioning more like an employee, particularly if the payment is linked to behaviours rather than deliverables.

Where contractors operate through personal service companies, IR35 rules require organisations to determine employment status for tax purposes. If a contractor is deemed to be inside IR35, all earnings, including any bonus-style amounts, must be processed through payroll with PAYE and NICs applied by the deemed fee-payer. Businesses that continue to pay such awards gross where IR35 applies risk significant tax, NIC, interest and penalty liabilities.

Clear documentation helps avoid confusion. Organisations should avoid using employee-style terminology such as “bonus” in contractor arrangements and should instead describe payments as project fees or completion payments where appropriate and only where consistent with the underlying commercial relationship. Status assessments and payment structures should be reviewed regularly so that evolving working practices do not inadvertently undermine the original IR35 analysis.

Section D summary

Section D has outlined the tax and payroll obligations that apply to bonus payments. Employers must ensure accurate PAYE and NIC treatment, structure salary sacrifice arrangements lawfully and meet all reporting requirements. Bonus-style payments to contractors require additional scrutiny to avoid IR35 risk and the possibility of HMRC challenge. Robust processes, coordinated planning between HR, finance and payroll teams and clear documentation reduce the likelihood of penalties and ensure compliance throughout the bonus cycle.

FAQs

Are bonus payments mandatory for UK employers?

No. There is no general legal obligation to offer bonus payments. However, if a bonus is contractual, or if entitlement has arisen under the terms of employment or through qualifying conditions being met, the employer must pay it when the relevant conditions are satisfied. Withholding a contractual or crystallised bonus risks an unlawful deduction from wages or breach of contract claim.

Can employers change a bonus scheme mid-year?

Yes, but only where the scheme wording allows for amendment or withdrawal and where changes are implemented lawfully. If documentation is silent or unclear, changing the scheme mid-cycle risks breach of contract or unlawful deduction from wages claims, particularly if employees have already performed on the basis of existing terms. Any change should be consulted on where the scheme is contractual, communicated clearly, applied consistently and implemented in a way that does not breach the implied duty of trust and confidence.

Do employees accrue bonus entitlement during maternity or parental leave?

Employees remain entitled to the proportion of a contractual bonus that relates to the period they were actively working before maternity, adoption or shared parental leave began. Employers cannot lawfully withhold the element of a contractual bonus that relates to normal work undertaken prior to leave. The compulsory maternity leave period (the first two weeks after childbirth) should be excluded from bonus calculations because no work is permitted during this time. For the remaining period, employers may pro-rate bonuses provided the approach is fair, consistent and non-discriminatory. Shared Parental Leave calculations can differ from maternity and adoption entitlements, but any pro-rating must still comply with equality law.

Can an employer withhold a bonus for misconduct?

Only if the scheme allows it and the decision is taken lawfully. If misconduct occurs outside the relevant performance period or the scheme wording is vague, withholding may be unlawful. Any reduction or non-payment should be consistent with the scheme rules, proportionate to the misconduct and supported by evidence. Employers should also consider whether the conduct is linked to a protected characteristic or protected activity, such as whistleblowing or trade union participation, as this may create additional legal risk.

Are bonuses pensionable?

Most bonuses are not pensionable unless the employment contract or pension scheme rules specifically include them in pensionable earnings. Some schemes treat only basic salary as pensionable pay, while others include certain types of bonus. Employers should ensure pension documentation and bonus scheme rules are aligned so there is no ambiguity about whether bonuses will be taken into account for pension purposes.

What happens to bonuses when an employee resigns?

This depends on the scheme wording and the timing of resignation. Many schemes contain conditions requiring the employee to be “employed and not under notice” on the bonus payment date. If clearly drafted, these clauses can prevent bonuses from being paid to employees who resign before payment. Where wording is ambiguous, tribunals tend to interpret it in favour of the employee, particularly where performance that generated the bonus was completed before notice was given. Employers should also review how PILON and garden leave provisions interact with bonus eligibility.

Can part-time employees receive bonuses?

Yes. Employers must avoid unlawful treatment under the Part-time Workers (Prevention of Less Favourable Treatment) Regulations 2000. Part-time employees should not be treated less favourably than comparable full-time employees simply because they work fewer hours. Pro-rating bonus awards for part-time hours is generally permissible, but excluding part-time staff altogether from a scheme may be unlawful unless objectively justified.

Can an employee challenge a discretionary bonus decision?

Yes. Although employers have flexibility in discretionary schemes, their decisions are constrained by implied duties of good faith, rationality and consistency and by the Equality Act 2010. Employees can challenge decisions through internal grievances and, in some cases, through tribunal claims for breach of contract, unlawful deduction from wages or discrimination. Tribunals will look at documentation, decision-making records and whether relevant and irrelevant factors were properly considered.

Do bonuses affect holiday pay?

They can. Guaranteed bonuses, and in some cases regular non-guaranteed bonuses that form part of “normal remuneration”, may need to be included when calculating certain elements of holiday pay, particularly the four weeks’ basic entitlement derived from EU law. One-off or exceptional bonuses that are not part of normal pay will usually not need to be included. Employers should review the frequency and nature of bonuses when deciding whether they should be reflected in holiday pay calculations.

Can employers operate multiple bonus schemes at once?

Yes, provided the schemes do not conflict and are clearly documented. Many businesses operate annual performance schemes alongside sales commission structures, retention bonuses or profit-share arrangements. Employers should ensure that eligibility rules, calculation methods and documentation for each scheme are coherent and that there is a clear hierarchy where contractual terms and scheme rules interact.

How do bonus payments interact with IR35 for contractors?

If a contractor is deemed to be inside IR35, all payments for their services, including any bonus-style or performance-related amounts, must be processed through payroll with PAYE and NICs applied by the deemed fee-payer. Paying such awards gross where IR35 applies risks additional tax, NIC, interest and penalties. Businesses should avoid describing contractor payments as “bonuses” unless this accurately reflects the arrangement and is consistent with the underlying status assessment.

Conclusion

Bonus payments remain a central feature of many UK remuneration strategies, but they carry significant legal and operational risks if not structured and managed carefully. Employers must balance the desire for flexibility with the need for clarity, consistency and compliance. A well-governed bonus scheme can reinforce organisational goals, support fair performance management and help attract and retain capable people. A poorly drafted or inconsistently applied scheme can lead to grievances, discrimination allegations and substantial financial exposure.

Clear documentation is the foundation of risk management. Employers should define eligibility, performance criteria, calculation methods and leaver provisions with precision. Discretion must be genuine and exercised in line with established contractual principles, not as an afterthought in response to difficult decisions. HR teams must also ensure that bonus-related communications, including informal discussions, align with written policies to avoid statements that inadvertently create entitlements.

Effective scheme operation requires fairness, transparency and robust record-keeping. Assessments should be evidence-based and moderated where necessary. Managers must understand the limits of their discretion, particularly when handling misconduct, absence or performance concerns. These operational safeguards directly influence the defensibility of bonus outcomes.

Tax and payroll compliance complete the picture. PAYE and NIC treatment, salary sacrifice and IR35 considerations must be integrated into the design and delivery of bonus schemes to avoid HMRC scrutiny. Cross-team coordination between HR, finance and payroll ensures that bonus payments are processed accurately and lawfully.

By approaching bonus schemes as legal frameworks rather than discretionary gestures, employers can maximise their strategic value while minimising avoidable risk. A disciplined approach to scheme design, communication, decision-making and compliance helps create a reward structure that supports business objectives and withstands scrutiny from employees, advisers and regulators.

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