ListenToTaxman.com

UK PAYE Tax Calculator / Salary Calculator

The number 1 free UK salary calculator tax calculator since 1998. Calculate salary, national insurance, HMRC tax and net pay

Salary v Dividends

A guide to tax efficient remuneration for Limited Company directors for 2019/20.

Clare DohertyThis Guide was written by Clare Doherty, Small Business Tax Expert at TaxKings Accountants. Clare now writes for Listentotaxman.com on matters relating to small business tax. She is very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the TaxKings Accountants website for contact details.

So you’ve taken the risk of starting up your own limited company? You're putting in all the hours to make sure that your fledgling enterprise is a success. It's understandable then that you'll want to remunerate yourself for all your hard work in the most tax efficient manner possible once, fingers crossed, the profit finally starts piling up.

The simplest option - adding you and your fellow directors (if applicable) to the company payroll and paying yourself a salary from the profit is certainly what the taxman would like you to do. It's also the least tax efficient. You will end up handing a LOT of that profit to HMRC by way of, not one, but TWO lots of National Insurance Contributions (NICs) - employers and employees - which, put together, are more than double the prevailing rate of income tax (20%). Instead, paying yourself by way of dividends (which are not liable to NICs), making pension contributions (like taking a second salary but only drawing on it in later life) plus considering other loans and benefits is the domain of the tax-savvy company owner. Yes, this can also be when things start to get complicated. Luckily TaxKings are on hand with a guide to the simplest, and most tax efficient, ways of paying yourself as a company director.

Paying salary via Pay As You Earn (PAYE)

The simplest option by far is to pay yourself a monthly salary via your company’s payroll. The obvious advantage of this approach is that it gives you a regular income from your business and can be based on an amount that covers your average monthly outgoings. If your business is not yet making a profit and is being subsidised by loans (either by directors, family members, the bank or outside investors), this is the option you should consider.

The downside of this approach is that you’ll end up paying income tax and National Insurance Contributions (NICs) on this monthly salary, making it a far from tax-efficient way of paying yourself. How much, you ask? Well, funnily enough,  there's this great site called Listen To Taxman which provides just such a calculator. If you were lucky enough to earn £50K each year, 25% of your income will be taken in tax/NICs: listentotaxman.com/50000

Above this, the percentage starts to go up considerably (earlier still if you are a taxpayer in Scotland). And, don't forget, as a company director, you are an employer too. So the company will be liable to that 11.4% employer NIC charge. Ouch. One way to combat this tax inefficiency is to pay yourself an amount up to either the current NI threshold or personal tax allowance, making what you earn NIC/tax free. Using this strategy, you pay yourself only a low, tax efficient  salary so that it does not attract personal tax. You must ensure that the salary is high enough to attract a National Insurance ‘stamp’ (in old money) to protect your future entitlement to state pension and other benefits.

Note that salary is a tax deductible cost for your business. So corporation tax is saved at 19%, the rate for 2019/20, on the gross salary paid to you by the company.

How do you pay yourself to cover those living expenses? One of the key benefits of operating via a limited company is that you can take advantage of tax planning measures not available with other business structures, such as sole traders and umbrella companies. Let's discuss these now.

Paying Dividends

Amounts you withdraw from your company above the basic salary should normally be treated as dividends. Dividends are only payable from post-tax profits so, if you’re not yet turning a profit and need to take out funds, you’ll have to do this via a salary instead. The main benefit of extracting dividends from your company is that, unlike salary, they are not subject to NICs. Do note however that that dividends, unlike salary, are not a tax deductible expense for your company, so your company does not save corporation tax on the dividends. Dividends are instead paid to shareholders when the business makes a profit. In a micro business, shareholders and directors are often (though not always) synonymous.  Because corporation tax - currently 19% - has already been paid on the profit through corporation tax, dividends will ultimately maximise a director's take home pay. In the example above of a £50,000 salary, the total tax percentage would be 20.5%. Quite a saving.

Crucially, paying dividends means that you are in control of your own finances. You can decide when to declare company dividends so you may want to postpone taking a certain amount of dividends. For example, if you have one extremely profitable year and expect the next year to be somewhat leaner, rather than pay tax in Year One on £80,000 profit (£30,000 of which would be taxed at a the higher rate) and in Year Two on £20,000, you can opt to pay yourself £50,000 each year. This flexibility, not available to other types of business owners, not only allows you to pay less tax but better allows you to manage your business cashflow and your personal living costs. You’ll pay tax on dividends you receive over £2,000 - the tax-free Dividend Tax Allowance at the following rates:

  • 7.5% on dividend income within the basic rate band
  • 32.5% on dividend income within the higher rate band
  • 38.1% on dividend income within the additional rate band

Note that the same level of dividend must be taken by all your shareholders of the same share class, unless you’ve made a specific agreement for certain shareholders to waiver their dividends. This should be considered if you have some shareholders who run the company and some who aren’t actively involved, as may be the case if you have outside investment.

If your business is carrying out research and development (R&D) qualifying activities then you’re better off paying your directors via a salary than dividends. Only salaries are included in an R&D tax credit claim, not dividends, so paying salaries will increase the scope of your claim.

Salary and dividends are not the only considerations for tax efficient remuneration as a company director. There are a great many other avenues to explore, I'll highlight the most common ones here but recommend that you seek some professional advice before continuing.

What is the most tax-efficient salary and dividend mix of 2019/20?

The answer depends on whether your company is eligible to claim the Employment Allowance (EA). The EA means that the first £3,000 of employer NICs are waived for companies. However, the rules tightened in April 2016 so that if you’re a director of a company with no other employees, you cannot claim EA.

For the 2019/20 tax year, if you pay yourself a £8,632 salary, you will pay no income tax or National Insurance at all. So, £8,632 is the most efficient salary to draw if you cannot claim the EA.

If you have employees and are eligible to claim the EA then you can pay yourself a salary of £12,500. At this threshold - the personal allowance - there is no income tax to pay. Ordinarily, you would also have to pay employees’ and employers’ NICs of £464 and £534 respectively. However, the employers’ NIC element is cancelled out by the Employment Allowance, so your only liability is £464 in employees’ NICs. Also, by taking a £12,500 salary, you save £735 in additional Corporation Tax you’d have to pay if you take a £8,632 salary.

£12,500 is the most tax efficient salary to take for the 2019/20 tax year if you can claim the EA - you’re better off by £270 - although there is a little more admin involved. We are often asked of the situation where a husband and wife are both directors taking a salary with no other employees. Our understanding of the legislation is that such a company would qualify for EA. However, since the clear intention of the legislation is to cease companies without ‘real’ employees from claiming EA, we would suggest erring on the side of caution and only claiming the EA in cases where both parties have an active role in the business.

Many of our clients choose to limit their total income to avoid the higher tax band, £50,000 for 19/20. To this end, we will detail the two different salary and dividend options available to you.

We will make some basic assumptions when preparing these calculations:

  • You are a UK resident
  • Your only income is your salary and dividends from your company
  • You are entitled to the full personal allowance
  • You have no student loan balance
  • Your company has sufficient post-tax profits to support these dividends

When it comes to dividend tax rates, the same rates apply in 2019/20 to all UK tax payers i.e. there is no separate Scottish rate for dividend income.

Option 1  - £50,000 income - If you can't claim EA

Salary: £8,632.

Dividends: £41,368

You will have basic rate tax to pay on dividends of £2,663.

This leaves £47,337 (£50,000 less £2,663) in your pocket after tax.

The company will save corporation tax of £1,640 with this strategy.

Option 2 - £50,000 - If you can claim EA

Salary: £12,500.

Dividends: £37,500.

You will have basic rate tax to pay on dividends of £2,663 plus the company will pay £464 Employer's NICs.

This leaves £46,873 (£50,000 less £2,663 and £464) in your pocket after tax.

The company will save corporation tax of £2,375 with this strategy.

Conclusion

While the first strategy results in more money in your pocket personally, there is a greater corporation tax saving using the second strategy. Overall, you would be better off by £270 if you choose the second option, assuming both options are available to you.

When working out dividend amounts, you must ensure that you have sufficient retained profit in your company, otherwise your dividend declaration would be classed as ‘illegal’. Always seek professional advice when setting your own  company’s remuneration strategy. The advice in this article is geared towards limited company freelancers, contractors and micro businesses with one or two directors / shareholders which we specialise in at TaxKings.

Pensions

Paying into a pension is not only a tax efficient way to take money out of the business. It also allows you to invest in your own long-term financial security. Making contributions from the company into your personal pension helps to build a pot of money for your retirement.

Paying pension contributions is tax efficient because you’ll reduce your company’s taxable profit and therefore your Corporation Tax liability. Making the contribution through your limited company is usually more tax-efficient than making the contribution from your own funds. For the 2019/20 tax year, the Corporation Tax rate is 19%. For every £100 your company earns as profit, you’ll pay Corporation Tax of £19, reducing the amount you can take from your company as a dividend to £81. On the other hand, paying £100 into a director’s pension fund effectively costs the company only £81 due to the reduction in Corporation Tax payable and, over time, the £100 investment can hopefully grow within the pension fund.

Generally, you can start withdrawing from your pension fund at the age of 55 and you now even have the option to ‘draw down’ up to 25% of your pension pot tax free. This can be used to help you retire early or to top up your income if you are still working. Again, you should take specialist advice on this, particularly if you plan to keep working while drawing a pension.

You can pay as much into your employee’s pension scheme as you like, subject to HMRC’s contribution limits and rules. Your contributions will be tax-free as long as they do not exceed the annual allowance, which is capped at £40,000 in 2019/20. We would generally recommend that the amount of employer's contribution must not exceed your company’s profit for the year as this could raise questions as to whether the amount has actually come from your company’s trading.

If you have a large amount of company profit that you wish to top up your pension with, you may be able to take advantage of the carry forward rule. This allows you to make use of annual allowances that have not been used in the previous three years, provided that you were a member of a registered pension scheme in these years. You must first use your full annual allowance for the current tax year before using any unused allowances from the previous three years.

You should also take into account your lifetime allowance. This is the limit on the amount that can be withdrawn from your pension scheme through either lump sums or retirement income, without incurring additional tax. The lifetime allowance is £1,055,000 for 2019/20. Again, you should discuss this with an independent financial adviser.

Director's Loans

There may be an occasion when you’ll want to borrow money from the company in the short term in the form of a loan. It’s a quick and easy way to get access to funds after all. Firstly, any money that you initially loaned the company forms part of your Director's Loan Account (DLA). If you loaned the business £10,000, your account is in credit to this amount and funds can be drawn on by you with no personal tax implication, as business cashflow allows.

On an ongoing basis, many company directors draw earnings as loans from the business and convert them to dividends and salary at a later date. Operating an overdrawn loan account in this way can have tax advantages when used  correctly. It must however be handled carefully, particularly in the event of insolvency where it can leave you personally exposed to business creditors.

There are tax implications in operating a Director's Loan Account (DLA) in debit, often unforeseen by unsuspecting company owners. The funds you take out of the company must be paid back within 9 months of the company’s accounting year end, otherwise, HMRC will charge the company 32.5% of the loan value. Consider the timing of a loan carefully. By way of example, if you take a loan on the first day of a company’s accounting year, you will have 21 months to repay funds to avoid the additional corporation tax charge. On the other hand, if you loan yourself funds on the last day of the accounting year, you would only have 9 months to repay it before the charge on the company.

If you borrow more than £10,000, HMRC considers this a ‘benefit in kind’ and you’ll need to pay income tax on the loan personally.  In addition, the company will have to pay Class 1A NICs.

Also, when a loan in excess of £10,000 is repaid by the director, no further loan over this amount can be withdrawn within 30 days. When this happens, the government’s view is that the director doesn’t intend to pay the money back and the amount over £10,000 will automatically be taxed.

Remember that a company is a separate legal entity to its directors so money in the company bank account correctly belongs to the company and not to its directors. Therefore, you should only operate loan accounts on a short term basis and within the £10,000 limit. If you find that your loan account is continually overdrawn, it may be beneficial to reduce it, or clear it by declaring it as salary or dividends, where profits allow. While this incurs higher personal tax liabilities, it reduces the risk to the directors and shareholders should the company ever become insolvent. In this scenario, you and any other directors will be required to repay all outstanding loans personally and in full.

Our advice? Borrow only small amounts – under £10,000 – for the short-term.

Benefits

Directors should always make use of any tax-efficient benefits-in-kind available to them. These might include employer-provided pension advice up to £500; employer supported childcare, cycle to work schemes and provision of ultra-low emission cars (below 75g/km emissions). It can even, in some circumstances, be worth taking an employer paid or subsidised mortgage, on which you will pay income tax and employer's NICS but not employee NICs. As always, approach all these strategies with caution and take advice in advance from your tax adviser. Getting them wrong can prove costly.

Two of the most discussed strategies with our clients here at TaxKings are:

  • Transferring a minority shareholding to a spouse to utilise the £2,000 dividend allowance
  • Setting up a rental agreement with your company for ‘use of home as office’

By far, the area of company tax that we are asked about most often is company cars. Approach with extreme caution! If you have a company car, this is classed as a benefit. This means the company will have to pay NICs at 13.8% and you’ll need to declare the benefit-in-kind on a P11D form and pay NICs on this benefit too. The tax on company cars can be as high as 37% for a car with high emissions of CO2. If a car cost £50,000 and you are a 40% taxpayer, you could pay £50,000 x 37% x 40% = £7,400 in tax. Always consider a cheaper car with lower fuel emissions. We'll return to this in a later article.

An alternative to a company car might be taking a company loan towards buying a car instead and claiming mileage allowances. Beneficial loans up to £10,000, as we have discussed, have no benefit-in-kind tax.

It makes a lot more sense to own your car personally and charge your company mileage at 45p per mile for the first 10,000 annually, then at 25p per mile thereafter. We use apps which makes recording your mileage simple and upload your journeys seamlessly into your accounts.

Conclusion

With the correct planning, forward-thinking and professional assistance, you can easily set up a bespoke, tax-efficient way to maximise income from your limited company in 2019-20. A well thought through remuneration strategy taking personal objectives into account can save hundreds, even thousands, of pounds in tax. Getting it wrong however - or doing nothing - can cost you the same in tax.

Like many business opportunities, it’s about identifying the challenges, planning ahead and taking good and timely professional advice. All tax efficiency measures should be discussed in advance with your accountant or tax professional – if you’re a contractor, freelancer or director of an owner managed business, we would advise you to speak with an accountant who specialises in providing accountancy services to this sector (we're happy to help).

Clare DohertyThis Guide was written by Clare Doherty, Small Business Tax Expert at TaxKings Accountants. Clare now writes for Listentotaxman.com on matters relating to small business tax. She is very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the TaxKings Accountants website for contact details.

This article was published in our Guides section on 29/04/2019.

Some Guides you may be interested in

More from our Guides section

330