Contractors' Questions: Is an annual bonus an IR35 sign I can ignore?

Contractor’s Question: I know it’s not ‘the done thing’ in a client-contractor engagement, but a new customer has just returned after the Christmas break and said they intended last month to give me a ‘festive bonus.’ A ‘one-off payment for excellence as a supplier’ is how I told them I’d prefer to refer to it.

How do I handle this with HMRC; or can I ignore it? I assume that the payment would be subject to income tax and National Insurance? Should it be treated like any client payment, or do I have to name it at any time, as I fear there could be consequences under IR35?

Expert’s Answer: The term ‘festive bonus’ certainly has the potential to be problematic from an IR35 perspective, as it clearly suggests a personal employer-employee relationship rather than a client-contractor business engagement.

If the plan is for the ‘bonus’ to be paid to permanent employees -- plus you as a contractor, then due to IR35, it would probably be wise to (politely!) reject it.

Accepting it would be a major 'red flag' to HMRC and a sure sign that you are a disguised employee.

If, on the other hand, the bonus is a discretionary additional payment made to your business in recognition of the services provided then the picture is looking a little clearer.

Indeed, it is not uncommon for companies to, for example, pay suppliers or contractors an additional fee if a project is completed ahead of schedule or within budget.

If this is what is happening in your scenario then I can’t see a problem, as long as the additional payment is made into your business bank account in the usual way.

Tax-wise, it could then be treated like any other form of business income with the usual option to draw a dividend. As you will be aware, National Insurance Contributions (NICs) are not payable on dividends but dividends are subject to a dividend tax.

As with all income, it’s worth bearing in mind that corporation tax is based on profits rather than turnover.

To sum up, I would say that the answer to your question comes down not only to terminology but also to the nature of (and reason for) the payment.

In order to be comfortable accepting the additional funds as a part of a business-to-business engagement, I would recommend first gaining confirmation that it is not a bonus that’s also being paid to permanent employees, and that the money will be paid into your business account.

Even if these conditions are met, if there is the opportunity for additional work with the client, then it may be simpler and ‘cleaner’ to negotiate a higher assignment rate for your next project instead of receiving a bonus.

The expert was Jon Cooper, sales and service lead at contractor accountants ADVANCE.