Tax Insider Reports: Withdrawing Payments as a Company Director
As a company director, it is important to ensure you are looking at possible tax planning strategies for each stage of a company's life from incorporation through to cessation when either the director leaves or the company closes.
Below is an excerpt from our popular tax report: Tax Tips for Company Directors.
In a private limited company, it is usual for a director to also be a shareholder and as such have the benefit of flexibility over the level of income and method of cash withdrawal by combining salary, dividends, and benefits in kind with the careful use of the Director’s Loan Account. Equalisation of income between spouses is also an important tax planning strategy.
The method that will result in the minimal amount of tax being paid both by the company and the shareholder director is dependent upon individual circumstances, but so long as the correct procedure is followed, confirmed by the correct paperwork, then effective tax savings can be achieved.
Being a director does not, in itself, make that individual an employee of the company. A directorship is an office, not necessarily an employment. However, if the company enters into a service contract with the director, the terms of which make the director an employee then that director is taxed under the same rules as any other employed earner. Many company directors are in this position.
HMRC are increasingly trying to contend that directors are employees, particularly for directors who work through IR35 Personal Services Companies (see section 1.1 Income tax - Tax Trap - Personal Service Companies).
- The National Minimum Wage does not apply to company directors unless they also have contracts that make them workers.
- One of the most important considerations when deciding how much to withdraw as salary (and/or bonus) is the treatment for NIC. Other considerations include the effect on state benefits (including the state pension) and child benefit claims.
Payment of a salary (and/or bonus) attracts employee’s NIC’s at the main rate of 12% on earnings above the Primary Earnings Threshold (PET) up to the Upper Earnings Limit (UEL). Payments in excess of the UEL attract an additional employee's NIC of 2%.
For the year 2018/19, the PET amount is £162 per week (£8,424 per year) and the UEL is £892 per week (£46,350 per year).
There would also normally be a charge to employer’s NIC of 13.8% should earnings exceed the Secondary Earnings Threshold (SET) limit (the same amount as PET at £162 per week, £8,424 a year for 2018/19). However, every company (except a company where the director is the only employee) can claim the Employment Allowance (EA) regardless of what that employee earns (NICA 2014 s. 2(4A)); this gives employers a discount of up to £3,000 on the employer's NIC payment.
The Employment Allowance
The Employment Allowance (EA) gives employers a discount from paying NIC of up to £3,000 per tax year. However, as detailed in the previous paragraph, a company where the sole employee is also a director, cannot claim. ER is preserved if there is more than one nondirector employee, or the role of the director is changed such that he is a sole employee but not also a director.
Optimal Salary Amount
For 2018/19, the suggested amount to allocate as salary to the director of a company where EA is unavailable is the PET amount i.e. £8,424. This amount will ensure that the year counts towards the state pension but that no employees or employers' NIC is paid. Any amount higher than this and both types of NIC will be due. Unfortunately, this means that £3,426 of personal allowances will be 'wasted' unless the director has other income against which the balance of allowances can be used. However, such 'other income' can include dividend payments from the company.
Should EA be available (because there are other employees earning above the SET limit), the optimal salary amount will be equal to the personal allowance (£11,850 for 2018/19) as no Employers NIC will be due; this is, of course, assuming that the personal allowance is not utilised elsewhere. Although Employees NIC will be payable at 12% on salary in excess of the primary threshold, this amount will be more than offset by a corresponding reduction in corporation tax.
Allocating a director the salary of £11,850 rather than £8,424 will mean an employee’s NIC payment of £411.12 (i.e. (£11,850 - £8,424) x 12%), but also mean an additional reduction in corporation tax of £650.94 (i.e. (£11,850 - £8,424) x 19%), producing an overall saving of £239.82 per director (i.e. £650.94 - £411.12).
As stated, in order to preserve the EA, there must have been at least one other employee, for whom the employer is liable to NIC but the other employee need not be employed for the full year. The rules state that there must be an employee 'at some point in the tax year' - which could technically mean just a month. (HMRC Guidance – Single Directors companies Employment Allowance point 4).
As with salary payments, a bonus is subject to income tax and Employee’s NIC for the recipient, plus Employer’s NIC for the company (unless 'EA' is available). Salary and bonuses are tax-deductible in the corporation tax calculation of the company and currently save 19% of corporation tax, but this saving does not fully offset the costs of Employer's NIC if the EA is not available.
Dividends must be paid in proportion to shareholdings, which is not a problem where there is only one director/shareholder, but should there be more than one shareholder or more than one director/shareholder then the taking of a bonus must be considered, not least for flexibility unless there is a system of 'Alphabet shares' in place (see section 6 – Alphabet Shares and Dividend Waivers)
Although the paying of a dividend will often be a more effective method of withdrawing profits, if the company is loss-making and has no retained profits, this will not be permitted. However, there are no such restrictions on the payment of salary or a bonus. Should a company find itself in the situation where a dividend is not possible then the declaring of a bonus will be the only way to withdraw any money. This will result in a reduction of corporation tax and possibly a refund out of which at least part of the bonus could be paid as the following section illustrates.
Timing Of A Bonus Payment
The amount of bonus that can be paid is related to and invariably depends upon the company’s results for the previous year. The determination of the date for when an earnings payment is made is usually the earlier of the actual payment date or the date when the employee becomes entitled to receive payment. However, for directors, the rules are specific and different - for them, payment is the earlier of:
- when a payment is made;
- when the director becomes entitled to the payment;
- the date when the earnings are credited to the company accounts;
- where the amount of earnings is determined before the end of the period to which they relate, then the date is the date that the period ends; and
- where the amount of earnings is determined after the end of the period to which they relate, then the date is the date of determination.
Therefore, it is possible to have a deduction for a bonus declared in a set of company accounts with the actual payment being accrued and paid at a later date. The benefit of using this route for payment is that, unlike a salary, a bonus is tax deductible for the company in the accounting year to which the payment relates and not when the payment is actually made. In addition, should the payment be related back to a year which already shows low profits, the taking of a bonus would make the profit reduce even further, resulting in a lower tax liability or even creating a loss with the potential of a tax refund, as Example 1 shows:
|Example 1 – Timing Of Bonus Payment|
|During the accounting year ended 31 July 2018, a company makes a profit of £10,000 before paying the sole director shareholder. The company has a negative balance sheet (i.e. the Balance Sheet shows that as at 31 July 2018 the company has more liabilities than assets), but it does have a bank account balance of £50,000. The director has not drawn a salary as he has other income of £11,850 against which his personal allowances are fully allocated. It is not possible to pay a dividend as there are no retained profits, so the company pays the director a bonus of £40,000 on 28 September 2018.
Note: No Employment Allowance is available. Directors Tax position:
Tax: £9,100 (£34,500 x 20%) + (£5,500 x 40%) Employees NIC: taken from the £40,000 payment.
Employer's NIC position:
Employer NICs: £31, 576 (£40,000 - £8,424) x 13.8% = £4,357
As a bonus is tax deductible for the company in the accounting year to which it relates and not in the year in which it is paid, taking account of the bonus and Employers NIC against the chargeable profit in the accounts for the year ended 31 July 2018 creates a loss of £(34,357) - (£10,000 - £40,000 - £4,357).
If the company had sufficient profits in the preceding 12 months (i.e. the accounting year ended 31 July 2017) to utilise the loss, then carrying the loss back would generate a tax repayment of £5,528 (£34,357 x 19%) out of which at least a proportion of the bonus could be paid.
The one condition for a bonus to be tax deductible is that it must actually be paid within nine months and one day of the accounting year end to which it relates. This can provide the company with a useful cash flow advantage, with the company benefiting from corporation tax relief (or even a refund as shown in Example 1) whilst the actual tax consequences for the director are deferred.
However, a bonus provided for in the accounts but not paid within the nine months and one day must be added back in the following year’s accounts as a previous year adjustment. The allowance will then be made in the period in which it is actually paid.
Although the company's corporation tax profit will be reduced, the date for having to account for the PAYE tax and NIC will be the date of determination (the last bullet point in the list under section 2.7 Timing of bonus). In Example 1, this date is 31 July 2018.
As can be seen from the example, the problem here is that the actual payment of the bonus might not be until some months after, such that the PAYE tax and NIC may be due before the payment.
A solution could be for the Board of Directors to meet prior to the accounting year end and agree to a commitment to pay the bonus, but not determine the actual amount. This way the amount for PAYE purposes will not be 'determined' by the end of the year, but at some later date when the accounts are drawn up.
For more Tax Tips for Company Directors, get the full report.