Bonus Payment & Tax

 

This article focuses on the tax treatment of bonuses paid to employees. As commissions are essentially treated the same as bonuses for tax purposes, this article also applies to the tax treatment of commissions. Even though this article focuses on employees, note that it is possible for bonuses and commissions to be paid to workers engaged as contractors.

What is a bonus?

A bonus is a payment in addition to a worker’s basic remuneration. The bonus can be discretionary or non-discretionary. An employee’s entitlement to a bonus can be tied to their performance outcomes. It could also be tied to the achievement of something else which the employer wants to reward, such as the employee attracting clients to the business or referring the employer to employees to fill available positions.

Examples of bonuses include:

  • Christmas or celebratory bonuses
  • Ex-gratia bonuses
  • Bonuses to encourage withdrawals of resignation
  • Bonuses to end industrial action
  • Retention bonuses
  • Performance bonuses
  • Referral bonuses
  • Sign-on bonuses

The list goes on. Some bonuses may be offered as a one-off payment. Others might be offered on a periodic basis. For example, an annual Christmas bonus.

What is a commission?
A commission is a payment made to a worker that correlates with sales generated for a business, or a similar performance marker. Some workers are engaged on entirely commission-only arrangements. Others might receive a commission to supplement a salary or wage.

Deduction for bonus payment

For income tax purposes, a bonus payment is similar to a salary or wage. A commission is also similar to a salary or wage. Thus, the payer of a bonus will generally be entitled to a deduction for the amount of the payment under section 8-1 of the Income Tax Assessment Act 1997 (ITAA).

For taxpayers on an accrual system, the bonus (as with standard salary and wage payments) is deductible in the income year it is incurred.

As set out in TR 97/7, an amount is incurred where there is a present money debt that the taxpayer is definitively committed to. The precise moment a taxpayer is definitively committed to making a bonus payment is really a question of fact and circumstances. In this regard, the terms of the underlying contract governing the relationship between the parties will often need to be considered. The definitive commitment to payment of a bonus might also be demonstrated by things such as a formal document where the business confirms the employee’s entitlement to payment and/or the employer’s commitment to making that payment.

It is possible to bring forward the timeline for when a bonus is deductible by making a payment prior to the end of an income year. Take the example of an employer who will become definitively committed to pay a bonus in July 2024. As a result, the employer will be entitled to a deduction for the bonus in the 2024/25 income year. The employer decides – on the basis the employee will be entitled to the bonus – to bring payment forward to 30 June 2024. In this scenario, the employer may be able to claim a deduction for the payment in the 2023/2024 income year instead of the 2024/25 income year.

It worth briefly raising that there are prepayment rules contained in section 82KZL to section 82KZO of the Income Tax Assessment Act 1936 (ITAA 1936) which can prevent a taxpayer from claiming immediate deductions for certain prepaid expenditure. These impose an obligation on taxpayers to spread certain over the eligible service period. However, the prepayment rules do not apply to payments under a contract of service (e.g. an employment contract), including for bonuses.

Bonus payment – Assessable income

The receipt of a bonus is typically assessable income to the recipient taxpayer under section 15-2 of the Income Tax Assessment Act (ITAA). In the alternative, it would also be assessable as ordinary income under section 6-5 of the ITAA.

A commission is typically assessable to the recipient taxpayer as ordinary income under section 6-5 of the ITAA.

Similar with the concept of an expense being deductible when it is incurred, income is generally only assessable when it is derived. The timing of income derivation really depends on the facts. Refer to TR 98/1 in which the ATO provides guidance on the principles of derivation. The terms of the contract governing the relationship between the parties (e.g. the employment contract) will clearly be significant to consider in determining when a bonus is derived. The ATO provide specific guidance on derivation for travel agents in TD 93/149 and for real estate agents in TR 97/5.

Bonus & PAYG withholding

Importantly, section 12-35 of Schedule 1 of the Taxation Administration Act 1953 (TAA) provides that entities that provide employee bonus payments will be subject to PAYG withholding obligations. The withholding obligation generally does not extend to bonuses paid to a contractor. In TR 2023/4, the ATO expresses its views on the distinction between an employee and contractor in the context of the PAYG withholding provisions.

PAYG withholding may also be required for non-cash payments, unless the payment is a fringe benefit.

Schedule 5 – Tax table for back payments, commissions, bonuses and similar payments is applicable for calculating withholding on bonuses.

That table treats as bonuses any payments which have a one-off nature that does not relate to work performed in a particular period. That includes payments which:

  • compensate an employee for a change to work location
  • amount to a sign-on bonus paid
  • amount to a lump sum allowance paid

There are two methods available for calculating the withholding from an additional payment such as a bonus. The first method which the ATO refers to as method A is the simplest method. The second method referred to as method B is more complex but can produce a more accurate withholding.

We’ve provided some further details on Method A below. See the ATO website for instructions on Method B.

Under Method A, the bonus is not simply added to gross earnings, with withholding calculated against the relevant table. If that were the case, withholding on additional payments such as bonuses s would often result in significant and over-inflated withholding in pay periods where a bonus is paid. The withholding calculation at Method A somewhat mitigates this by limiting withholding on additional payments to the additional withholding that would be required to the paid if the bonus had been evenly spread out over the financial year and then multiplying that additional withholding by the number of pay periods in the financial year. As a result, it is still the case that withholding is greater in pay periods where a bonus is received, but potentially not as high as would otherwise be the case if the payment was merely added to the employee’s salary or wage for a particular pay period.

Method A

The instructions for completing Method A are as follows:

  1. Work out your employee’s gross earnings excluding any additional payments for the current pay period. Ignore any cents.
  2. Use the relevant tax table to find the amount to be withheld from your employee’s gross earnings in step 1.
  3. Add any additional payments to be made in the current pay period together and divide the total by the number of pay periods in the financial year (that is, 52 weekly pay periods, 26 fortnightly pay periods or 12 monthly pay periods). Ignore any cents.
  4. Add the amount at step 3 to the gross earnings at step 1.
  5. Use the relevant tax table to find the amount to be withheld from the amount at step 4.
  6. Subtract the amount at step 2 from the amount at step 5.
  7. Multiply the amount at step 6 by the number of pay periods used in step 3.
  8. Multiply the additional payment being made in the current pay period by 47%.
  9. Use the lesser amount of step 7 and step 8 for the withholding on the additional payment. Ignore any cents.
  10. Work out the total PAYG withholding for the current pay period by adding the withholding on the additional payment (step 9) to the withholding on the gross earnings (step 2).

Bonus & Superannuation

There is an obligation of employers to make superannuation guarantee contribution payments on behalf of entitled workers. This obligation only extends to amounts provided to employees which are salary or wages and meet the definition of ordinary time earnings. Salary or wages are the remuneration paid to employees for their service. This includes all bonuses paid because of the employee’s service (not payments on a personal basis). Ordinary time earnings include earnings in respect of ordinary hours of work but not overtime hours. Accordingly, most forms of bonuses are ordinary time earnings because they are at least partially referrable to the performance of ordinary hours. That includes bonuses which are not directly tied to the performance of ordinary hours. For example, seasonal bonuses or goodwill bonuses.

Unless, a bonus is wholly referrable to the performance of overtime hours, it will not generally meet the definition of ordinary times earnings. Thus, bonuses s which partially relate to overtimes hours and partially to ordinary hours will still be considered ordinary times earnings even though they do partially reward the employee for efforts in providing services outside of ordinary hours. That is, there is no pro-rating or non-OTE where a majority of the payment is attributable to non-ordinary hours performed.

Bonus & FBT

Generally, a bonus will not attract fringe benefits tax. However, FBT might apply where the relevant bonus arrangement takes the form of the provision of a non-cash benefit or a payment for expenses incurred the employee, subject to mitigating rules – for e.g. where the relevant benefit is an exempt benefit or where, under the otherwise deductible rule, the benefit would have been deductible to the employee.

FBT only applies in respect of benefits provided to an employee, or on their behalf. Thus, FBT will not apply to benefits provides to genuine contractors.

This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.