Gratuity and bonus schemes: a taxable benefit

This article is part of a series on profit-sharing plans, an interesting alternative for companies wishing to improve employee retention within their ranks.
Over the past few months, our team of Canadian tax consultants has assisted a number of companies in the development and implementation of certain profit-sharing plans, and has decided to write articles on the subject in order to inform even more entrepreneurs keen to offer their employees the best possible working environment.

What is a taxable benefit?

A taxable benefit can be defined as an additional good or service granted by the employer to the employee, in addition to the employee’s basic salary.
It can take different forms, such as the granting of gifts, bonuses or rewards.
The taxable benefit is a means of gratification and reward for the employee which, as we will explain later, is generally linked to the company’s financial performance.

Of course, taxable benefit essentially means that this type of benefit is subject to tax.
In other words, the employee must declare this benefit on his or her annual tax return, as it is considered part of his or her taxable income.

There are several types of taxable benefits:

• Rewards and gratuities in cash or kind
• Performance or year-end bonus
• Retroactive payments or salary supplements
• Non-monetary benefit such as free use of company property

We’ll concentrate here on the bonus.

Overview of the concept and definition of the bonus scheme: how does it work?

Setting up a taxable benefit such as a gratuity or bonus scheme is very simple and flexible and it involves little legal, accounting or tax gymnastics. This type of plan can also be directly linked to a company’s financial performance. For these reasons, it is the plan most frequently used by private companies. Although some companies may wish to introduce a more elaborate and symbolic plan, many end up returning to this scheme not only for its simplicity, but also for its flexibility.

The broad outlines applicable to the operation of this type of plan

The implementation of a bonus plan involves the payment of a monetary amount to certain employees. This amount is determined according to a precise agreement, to ensure predictability and a degree of certainty for the employees who benefit from it.

A question of calculation

For example, some plans include the payment of a bonus equal to a certain percentage of the company’s annual profits, a percentage of the company’s annual sales, a percentage of the gross or net results of a division or department, or a percentage of the sale price of shares in external transactions.

Although this type of benefit is simple and flexible, it does involve a monetary outlay, and therefore requires greater management of the company’s cash flow.
As a general rule, this represents income for the employee when the bonus is received, and a deductible expense for the company when the amount is payable.
It is sometimes possible to carry out some tax planning to optimize the timing of the deduction for the company and the timing of taxation for employees.

Case studies and analysis

Recently, an established technology company decided to change its bonus policy. Previously, the company had a high turnover rate within its team, and was having difficulty recruiting new employees, especially in key positions. With the old policy, the bonus for the applicable year was paid six months after the end of the year (e.g.: payment on June 30, 20X2 for the year ended December 31, 20X1).

Bonus program, a gift for key employees and executives

The employer has therefore introduced a new bonus program for executives and key employees, which is now based on the company’s results.
To this end, the Board of Directors annually determines the budget envelope allocated for the bonus plan as a whole, and the criteria applicable to the achievement of financial objectives.
The General Manager is then responsible for distributing the total amount of the envelope among executives and key employees, based on the achievement of predetermined individual objectives (quantitative and qualitative).
The total amount of bonuses available is therefore based on the achievement of certain corporate, divisional and individual objectives.

Change in bonus payments

Executives are informed of their bonus entitlement three months after year-end.
However, in order to encourage greater medium- and long-term retention within the company, the total amount attributable to bonuses has been increased, and bonuses are now payable over a longer period of time.
Bonuses are only paid to executives three years less one day after they are awarded, provided they are still employed by the company at that time (e.g.: payment on December 30, 20X4 for the year ended December 31, 20X1).

What has changed in employee retention?

The company noted that by delaying bonus payments over time, this had the effect of keeping managers motivated in the medium and long term, and thus fostering involvement and attachment within the company.
The implementation of this bonus system also had the effect of rewarding and retaining employees, while limiting, in the short term, significant fluctuations in its working capital, the latter objective being essential for the company in order not to jeopardize its short-term cash position.

In tax terms, the bonus is taxable for the employee and deductible for the company at the time of payment.
However, a liability (bonus payable) must be recognized in the company’s financial statements when the amount granted is known and determinable.

This simple plan did not require a complex agreement like some other plans, and enabled the company to strengthen the retention of its key employees while pursuing the company’s short-, medium- and long-term objectives and strategic vision.

Finally, the bonus scheme offers considerable advantages for companies.
It aligns employees’ interests with those of the company, encouraging greater involvement and motivation.
As well as improving employee retention, this scheme can be a powerful tool for attracting new talent.
Incentives and bonuses offer flexibility in human resources management, making it possible to reward outstanding performance without adding to the company’s fixed costs.