As a director of your small company you have complete autonomy over when and how you are paid. What do you need to consider before committing your company to a salary if cash is tight?
Salary planning
A question we’re often asked is whether drawing a salary from your company is, for tax purposes, a good idea, where the business is struggling financially. Of course, unless you have other income or savings to fall back on, you’ll need money from your company to meet your living expenses. If profits are small or non-existent, dividends aren’t an option so you’ll need to take salary instead.
Tax efficiency
As a director shareholder, two independent tax regimes affect the tax efficiency of salary, namely corporation tax (CT) for the company and income tax (and NI) for yourself.
Tip. A single-person company is now less tax efficient given the increase in CT rates and lack of employment allowance to cover employers’ NI. NI efficiency can be improved by making your spouse or partner a director shareholder and paying them directors’ fees or, if they do some work for the company, a salary.
Salary and CT efficiency
Even if your company makes losses it’s entitled to a CT deduction for salaries and benefits that it pays, e.g. employer pension contributions.
Tip. Creating a loss by taking a salary or benefits has a CT advantage. The loss can be carried back to the previous accounting period, and if your company paid CT it can claim a refund. If no CT was paid the loss can be carried forward to reduce it on later profits.
Tip. Employer pension contributions, although tying up money for the longer term, also reduce CT and have personal income tax advantages.
How much salary?
Usually the advice for director shareholders is to start with a salary of no more than the NI earnings threshold and then add dividends or low-tax perks to arrive at the most tax-efficient level of income. However, for true tax efficiency you need to take account of any other taxable income you expect to receive during the tax year.
Tip. Unlike employees, the NI threshold (£12,570 for 2023/24) for directors is annual. This means you can pay a whole year’s salary in one month with the same NI result as if it were over the year.
Don’t be too hasty with salary
Short of having a crystal ball, you can delay the salary decision until 5 April 2024. If you need to take income sooner but circumstances mean you can’t take it as dividends , borrow the money and repay it from your salary. Alternatively, to secure the CT deduction without the cash outflow, your company can recognise your salary by crediting your director’s loan account until such time as it can afford to pay it. This means tax efficiency can be achieved for the mere cost to your company of PAYE tax and NI (see The next step ).
Tip. For single person companies, the optimum salary for NI-efficiency profit extraction is equal to the employers’ NI threshold of £9,100.
To keep all options open for as long as possible, and help your company’s cash flow, don’t commit to a salary too early. If cash is still tight into April 2024, the company can credit your director’s loan account with salary but only pay out the related tax and NI.
The next step
HMRC's guidance on when PAYE is due (part 2)
HMRC’s guidance on when PAYE is due (part 1)
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.