Director-shareholder remuneration: PAYE or dividends?

Director-shareholder remuneration: PAYE or dividends?

We’re now a month into the new personal tax year (6 April 2021 – 5 April 2022); an ideal time for Shareholder Directors to take stock of their remuneration plans for the coming year given the annual earnings period has just commenced.

The two main routes of being paid for a shareholder director are via PAYE earnings and dividend. Most often we would expect to see a blend of the two, depending on the shareholder-directors personal and business circumstances. We have the added complication this year around the tax credit available in the Director’s company where the Director’s company has been paid by an end user of the Director’s services and has deducted income tax and national insurance on payment of the company invoice as a result of changes commonly referred to as IR35.

Salary/Fees/Bonuses

Directors will most often receive a salary under a service contract, similar to an ordinary contract of employment with the company. They may also receive fees for their director duties and/or bonuses.

Each of the above types of payment are taxable as earnings on the director. Where this is paid in cash form e.g. as monthly salary, quarterly fees or a bonus payment the director is liable to income tax and Class 1 NICs (covered below).

Income Tax and NICs must be deducted at source by the company under PAYE. This also applies to payments in any form which can be converted into cash.

Income Tax

Broadly speaking, Directors whose income falls into the basic rate band suffer tax on earnings at an effective rate of 32% (being 20% income tax and 12% Class 1 primary NICs), where the income falls into higher rate an effective 42% rate (40% income tax and 2% NICs) and additional rate 47% (45% income tax and 2% NICs). For 2020/21 the tax rate bandings are:

*The personal allowance is tapered between £100,000 and £125,140. Above £125,140 income you do not get a personal allowance.

National insurance contributions (“NICs”)

Each payment made to the director should be totalled for the tax year – for both tax and NICs purposes this should then be charged on a cumulative basis. No Class 1 NICs are payable until the directors earnings exceed the annual primary threshold. For the 2021/22 tax year this is £9,568. Once the cumulative earnings exceed the upper earnings limit, £50,270 for 2021/22, primary Class 1 NICs are capped at 2% for future earnings in that tax year.

The company’s liability for secondary Class 1 NICs is also calculated on a cumulative basis with slightly different initial threshold of £8,840.

If a director is paid salary/fees in regular monthly intervals, like many salaried employees, then this treatment will distort their monthly deductions. In such circumstances it is possible for a director and company to agree that employers can calculate and deduct NICs in the same way as for salaried employees; on a monthly earnings period. However, at the end of the tax year the total earnings received by the director must be compared to the annual limits. This is to ensure that the overall NICs liability for both the director and employer is calculated correctly on the annual earnings period basis.

If you are a director and have had NICs deducted on a monthly earnings period basis we recommend that you check with your payroll team, or your Azets personal tax contact, that your NICs liability has been correctly calculated for the 2020/21 tax year that has just ended. 

From a company perspective the salary paid to a director is deductible for calculating profits chargeable to corporation tax.

Dividends

The ability to pay yourself via dividends is one of the main attractions to setting your business up as a company. The key benefits are a reduced rate of income tax, an additional tax free allowance and they’re outside the scope of NICs.

From a company perspective as payment of dividends is from distributable profits there is no corporation tax deduction available, however, payment of dividends does mean the company doesn’t have the obligation to pay 13.8% NICs.

In addition to the standard personal allowance individuals are also entitled to a dividend tax allowance of £2,000 taxed at zero rate. 

If you receive only dividend income then you can receive up to £14,571 without paying any income tax or national insurance contributions.

Example

£100,000 paid via salary = income tax £27,432, NICs £5,878.84, and take home pay is £66,689.16

Whereas

£100,000 paid as dividend = £18,839, therefore take home £81,161

Dividends would usually be declared in the minutes of a board meeting and should be evidenced by a dividend voucher or counterfoil. Dividends can be paid at any time as long as the company has sufficient distributable profits. We frequently see shareholder directors make monthly interim ‘dividend’ payments to themselves, and then top up/confirm the position at the year end. If this route is followed careful consideration should be given each month to management accounts to check that the director is comfortable that there are sufficient distributable profits and the interim dividends should, each time, be voted for and evidenced appropriately.

Previous general approach

Historically speaking, we have seen many director-shareholders who have paid themselves a minimal salary – essentially up to the annual general threshold for NICs – and then dividends for the balance of their income.

The ongoing Covid-19 pandemic and government fiscal stimulus suggests that this approach may not be the best approach in future.

We have seen clients who have followed this route find themselves unable to access government income support and who have then taken out bounce back loans where available and used these to make their same annual dividend payments. This would generally be fine, so long as the company ends the year in a position to pay dividends, otherwise the dividends are considered ultra-vires and will either be treated as a loan by the company to the director or as earnings.  

So what should I do?

Firstly, check that your income for 2020/21 is properly understood, reflected by the correct paperwork and is provided to your tax advisor as soon as possible.

Secondly, in terms of structuring your remuneration for 2021/22, this depends on your personal circumstances and we suggest that you discuss this with your usual Azets contact or a member of our Tax team before making any decisions.

We would generally suggest a blended remuneration package of salary, bonus, benefits (especially tax fee benefits, such as pension contributions from the company) and dividends. 

Additionally, if you have a credit directors loan account (the company owes you money) then you may wish to charge the company interest on the loan.