Tax free bonuses from an employee owned company

Q: How does this work in practice?

Illustration only. An employee owned trading company pays every employee with at least six months' service a bonus of 10% of salary, capped at £3,600. Maria earns £36,000 and receives £3,600 in June 2026. No income tax is deducted, saving her £720 at the 20% basic rate. Her salary is already above the primary threshold, so 8% employee National Insurance of £288 is still deducted, and the company pays 15% employer National Insurance of £540. A colleague earning £50,000 would receive £5,000; £3,600 is exempt and £1,400 goes through PAYE as normal pay, with National Insurance on the full £5,000. HMRC says at EIM03050 that there is no need to report an exempt bonus to HMRC, except any excess over the limit. The employer must be able to show that the conditions were met if asked, so keep the scheme rules, the eligibility list and the calculation for each award.

A company that is controlled by an employee ownership trust can pay each employee up to £3,600 of bonus in a tax year free of income tax, under Chapter 10A of Part 4 ITEPA 2003. The bonus must be paid under an all employee scheme on equal terms, and the company must meet trading, ownership and office holder tests. The exemption covers income tax only, so employee and employer National Insurance are due on the full bonus.

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What exactly is exempt?

Bonuses are normally taxable as earnings under section 62 ITEPA 2003. Section 312A switches that off for “qualifying bonus payments” made by a company, up to a total chargeable amount of £3,600 per employee in a tax year (the “exempt amount”). Anything above £3,600 is taxed in the usual way. The relief has applied to payments made from 1 October 2014, and the Treasury can change the figure by order under section 312A(9).

HMRC’s Employment Income Manual at EIM03051 adds three practical points. The employer must be a company, so sole traders and partnerships cannot use it. The payment must go from the employing company to the employee or former employee, so a bonus routed through a third party does not qualify. And it must be a cash payment: if a bonus is delivered partly in cash and partly in shares, only the cash element can be exempt.

For background on how the trust itself is set up and the capital gains relief for the vendors, see employee ownership trusts.

Which companies can pay a tax free bonus?

Section 312B lists the conditions. The payment must not be regular salary or wages, and the employer must:

Meet the trading requirement (section 312D) throughout the qualifying period: it must be a trading company, or a member of a trading group, whose activities do not include non trading activities to a substantial extent.
Meet the indirect employee ownership requirement (section 312E) throughout the qualifying period. The trust must satisfy the controlling interest requirement in section 236M TCGA 1992 (more than 50% of the ordinary share capital, votes, distributable profits and assets on a winding up) and the all employee benefit requirement.
Meet the office holder requirement (section 312F) when the bonus is paid and on enough days in the qualifying period. Directors and other office holders, plus employees connected with them, must not exceed two fifths of all employees and office holders.
Not be a service company (section 312G), which covers managed service companies and companies whose business is mainly supplying their staff’s services to the people who control them.

The qualifying period is normally the 12 months ending on the day of payment. If the trust first acquired control during those 12 months, the period starts when the ownership requirements were first met (section 312B(3)). The office holder test must be met on at least the number of days in the period less 90, scaled down for a shorter period (section 312B(4)). So a company does not have to wait a year after the trust buys in before paying its first exempt bonus.

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Who has to be allowed to take part?

The participation requirement in section 312C(1)(a) says everyone in relevant employment when the award is determined must be eligible. In a group, that means employees of every group company. HMRC confirms at EIM03053 that this includes employees based outside the UK.

The law allows only these exclusions:

Employees with less than a minimum period of continuous service set by the employer, which cannot exceed 12 months (section 312C(3)).
Employees found guilty of gross misconduct in the 12 months before the award is determined, or dismissed for gross misconduct or summarily dismissed before payment (section 312C(4)).
Directors, for qualifying bonus payments made on or after 30 October 2024 (section 312C(2A), inserted by Finance Act 2025). HMRC’s FAQ at EIM03053 confirms that one or more directors can choose to be left out without the others having to be.

Former employees can still receive a qualifying bonus if it is paid within 12 months of their employment ending, and a payment to personal representatives qualifies if made within 12 months of death (sections 312B(1)(h) and 312I(4)).

Can different employees receive different amounts?

Yes, but only by reference to the factors allowed by the equality requirement. Under section 312C(6) the amount may depend on remuneration, length of service or hours worked, and nothing else. If more than one factor is used, each must give a separate entitlement and the bonus must be the sum of them (section 312C(8)). HMRC’s example at EIM03054: 3% of salary multiplied by years of service fails, but 3% of salary plus £100 per year of service passes.

The equality requirement is also broken if some participants get nothing (section 312C(7)), or if the scheme is likely to confer benefits wholly or mainly on directors, the highest paid, or staff in a particular part of the business (section 312C(9)). HMRC warns at EIM03054 that separate bonus pots based on the profits of individual divisions or group companies will usually fail. Its FAQ also says that basing the bonus on actual hours worked is likely to breach the rule where zero hours staff are eligible.

Why is National Insurance still due?

The exemption sits in the income tax legislation only. HMRC states at EIM03050 that it “does not extend to NICs, which follow the normal treatment for earnings”. The bonus is therefore a payment of earnings through payroll. For 2026 to 2027 a category A employee pays 8% on earnings between the primary threshold and the upper earnings limit and 2% above it, and the employer pays 15% above the secondary threshold. See employee National Insurance rates and employer National Insurance rates.

The bonus also cannot be swapped for salary. Section 312H excludes a payment if the employee gives up other earnings in return for it, or agrees to take it instead of some other employment income. A salary sacrifice style arrangement therefore kills the exemption.

How does the £3,600 limit work with several payments or employers?

The exempt amount is set against payments in the order they are made (section 312A(6)). If an employee works for two unconnected employers, each can pay up to £3,600 tax free. Where the employers are in the same group, one £3,600 limit covers them all (section 312A(4)). In HMRC’s EIM03051 example, group bonuses of £2,500 and £4,000 give £3,600 exempt and £2,900 taxable.

Where two or more payments made on the same day take the total over the limit, the formula in section 312A(7) shares out the remaining exempt amount in proportion to the size of each payment.

How does this work in practice?

Illustration only. An employee owned trading company pays every employee with at least six months’ service a bonus of 10% of salary, capped at £3,600. Maria earns £36,000 and receives £3,600 in June 2026. No income tax is deducted, saving her £720 at the 20% basic rate. Her salary is already above the primary threshold, so 8% employee National Insurance of £288 is still deducted, and the company pays 15% employer National Insurance of £540. A colleague earning £50,000 would receive £5,000; £3,600 is exempt and £1,400 goes through PAYE as normal pay, with National Insurance on the full £5,000.

HMRC says at EIM03050 that there is no need to report an exempt bonus to HMRC, except any excess over the limit. The employer must be able to show that the conditions were met if asked, so keep the scheme rules, the eligibility list and the calculation for each award.

What mistakes come up most often?

Leaving employees out because they work for a different group company, are based abroad or are on probation longer than 12 months.
Calculating bonuses by reference to team or divisional profit, or by multiplying salary by years of service.
Assuming the bonus is free of National Insurance and under budgeting employer costs.
Offering the bonus in exchange for a pay freeze or a reduced salary increase, which section 312H treats as excluded.
Paying before checking the two fifths office holder test, particularly in small companies with several family directors.
Treating shares awarded through a Share Incentive Plan as part of the £3,600; only cash counts. For ordinary bonus taxation, see how bonuses are taxed.

If HMRC opens a check into your return, tax investigation insurance pays your accountant’s fees. Solar Protect cover pays up to £100,000 with no excess; it never pays tax, interest or penalties. Read how our cover works or get a quote.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 24 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.