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Director/shareholder reward packages: The dynamics have changed

Introduction

The introduction of the Employment Allowance (“EA”) allows employers a discount of up to £2,000 off their liability to Employers’ NIC. This has added another factor into the salary vs dividend debate.

There is one other complicating factor as well. The level of other taxable, non-dividend, income enjoyed by the director/shareholder.

If there’s no other income

A salary equivalent to the director’s personal allowance is most efficient. The additional NIC paid by the director (at 12% on the excess over £8,060) is more than compensated by the additional corporation tax saving at 20%.

With no other employees, this works for companies with up to 5 directors/ shareholders.

What if the director has other income?

Many directors own the company premises, and enjoy a rent from that. Where rent (or indeed any other taxable income) is enjoyed by the director, a little more care is needed. The optimal position would be to create total taxable income (excluding dividends) of exactly £10,600 (for 2015/16). So if the director was receiving rent of £3,000 a year, the ideal salary would be £7,600.

What about pensions?

There are two aspects to this.

Contributions to a private pension scheme
Dividends do not count as pensionable income, and so tax relief on personal contributions would be limited to the amount of taxable salary. (Rent doesn’t count either).

The simplest way around this is to get the company to make an employer contribution, but you may need a different kind of pension scheme, and this may need to be negotiated/agreed with fellow directors.

I had just such a case where one of three directors wanted to top up his pension. Unfortunately, the wider savings from the low salary route meant his tax relief was limited to just £5,000, as he already had two smaller schemes running, and the company did not have sufficient profits to get full tax relief on even that small amount.

State pension entitlement
Employees are credited with a year’s worth of contributions if their weekly earnings exceed £112.00 (2015/16 rates). Therefore, the director will need a salary of at least £5,824 to add another year to their state pension accrual. In the example above, a salary of £7,000 meets the criteria, but what if the rental income was £6,000?

Voting a salary of £5,824 would take the director into income tax, as total income would exceed the personal allowance.

At 2015/16 rates, this would impose an income tax bill of £244.80 on the director, but would add a year to the pension entitlement. The cost-benefit decision is personal to each individual; is an extra year’s pension worth paying that tax?

The factors to consider are:

  • how many years before you can take your pension,
  • how long you think you’ll be around to enjoy it, and
  • how much more could you generate in income by saving that tax over the years before you retire/

among others.

Creating alternative income

If the circumstances allow, it may be more efficient to draw one’s income as rent or interest from your own company, rather than by way of salary.

Rent

Any rent charged must be at a market rate. We would suggest that a written agreement is drawn up, making it clear who is responsible for repairs etc., as well as covering the amount of the rent.

Interest

A director can only charge interest to his company if he has a loan account in credit, and there is an obligation on the company to pay interest. Any “interest” paid on a loan which was intended to be interest-free could be challenged and treated as remuneration. In order to avoid any uncertainty, we would suggest a written agreement, which makes clear the terms of the loan. The agreement does not need to be onerous, but a clear statement can help to avoid later disputes.

Action

The start of a new tax year is a good time to review your financial position, as many rates and allowances change. Thankfully, for directors’ salaries, the annual earnings period means you haven’t lost out if your review has not yet been completed.

Contact your adviser, or drop us a line if you’d like a review done of your personal situation.

Numbers (UK) Limited

5 May 2015

A Government give-away (with conditions)

Introduction

One of the goods things to come out of recent budgets is the new holiday for Employer National Insurance Contributions (“NIC”). The Employment Allowance allows small and medium enterprises (“SME”) to deduct up to £2,000 from their employer NIC payments.

The details

The holiday is worth up to £2,000 per annum. This starts on April 6th 2014, and must be claimed by qualifying employers. HMRC are expecting employers to take the deduction as early as possible, so many will see the benefit on 19 May 2014 (when the first payment is NOT made.

You can only claim it once, even if you run more than one PAYE scheme. If you are part of a group, only one company can claim the allowance.

Who cannot claim?

The main exclusions are companies and organisations that provide “public sector” services. These include:

  • NHS services
  • General Practitioner services
  • the managing of housing stock owned by or for a local council
  • providing a meals on wheels service for a local council
  • refuse collection for a local council
  • prison services
  • collecting debt for a government department

but also includes those;

  • who employ someone for personal, household or domestic work, such as a nanny, au pair, chauffeur, gardener, care support worker
  • already claim the allowance through a connected company or charity
  • are a public authority, this includes; local, district, town and parish councils

How do we claim it?

The claim is made using your own payroll software, or by using HMRC’s own Basic PAYE Tools. You can check how much of the allowance you have claimed by logging on to HMRC’s online service and “Viewing PAYE Liabilities and Payments’.

Arrangements have been made for those employers who are exempt from online filing, and more detailed guidance is available on HMRC’s website.

Other issues

If you have more than one payroll, you can only claim against one of them. At the end of the tax year, if you have not claimed the whole £2,000, you can apply to HMRC to have the balance refunded on the second PAYE scheme.

If you do not apply for a refund, and have an unused balance (i.e. you have paid Employer NIC that you haven’t covered with the EA), you can set the balance off against future PAYE liabilities. Please note, you cannot generate an unused balance in any other way. Neither can employer NIC in excess of £2,000 per annum cannot be used to generate an unused balance.

You can claim EA up to four years after the tax year has closed, but HMRC will set off the refund arising against future or existing PAYE liabilities, unless you specifically ask for a refund.

So what will you do with the extra cash?

A maximum saving of £166.66 per month is not life-changing, but it can be put to good use.

You could give a pay rise to a lower paid worker. Passing on part of that could mean a significant increase (in percentage terms) for that employee. It can also help to head off any discontent. Pre-empting the rise in the National Minimum Wage (“NMW”) can present you as a caring employer, rather than one who has to be forced into giving pay rises.

However, you should consider taking the opportunity to remind them of the difficulties faced by small businesses, and their critical part in making you’re a success.

Alternatively, you could just bank the savings. Cash is king, and particularly when the banks are still not providing enough finance to the SME sector. £2,000 a year may not sound like much, but it can help as a source of free funding.

Perhaps a better alternative would be to use it to invest in updated equipment. If your credit rating is good enough, there are sources of cheap funding around. Replacing older computers, perhaps on a lease or HP contract, will increase productivity, and boost morale. It will also address the need to move on from Windows XP machines, following Microsoft’s withdrawal of support for that operating system.

Words of warning

It is unlikely, but you could lose eligibility part way through a tax year. If that happens, you have to make the appropriate change to your payroll software, and repay the Employment Allowance previously given!

If you use an outside payroll agency, you will need to advise them if you qualify, and of you cease to qualify. Some payroll agencies do not know enough about your business to determine whether you qualify.

If you change payroll software, you may need to file another EPS, to activate the Employment Allowance within the software, although HMRC will roll forward the entitlement each year.

Some employers run a separate payroll for paying senior staff, to maintain confidentiality. If you have more than one payroll, perhaps run by different providers, YOU will have to decide which one gets the EA, and advise all providers accordingly.

You can only deduct the EA from the Employer NIC, not the employee NIC and/or PAYE deducted. Make sure your payroll staff or provider know this, as there are now penalties for late payment of PAYE/NIC.

You will need to maintain records proving entitlement and the amounts claimed, for three years after the end of the tax year to which they relate. You cannot rely on HMRC to record the amounts claimed, and proof of entitlement.

What should we do next?

So there are a few thoughts for consideration. If we can help in your decision-making, please let us know.