So you’ve set up your new business, got your head around the bookkeeping, and your other responsibilities as a company director. You’ve even started to get some paying clients and now you want to pay yourself a salary. But what’s the best way to go about this? How can you do it tax efficiently? Should you run a payroll or take money out of the company as a dividend?
Don’t worry! All your questions are answered below.
What is Payroll?
In basic terms, a payroll is a list of the company’s employees with an indication of their salary. In the UK, this information is reported to HMRC via their RTI (real-time information) system on a PAYE (pay as you earn) basis. This means that income tax and NICs (national insurance contributions) due on employees’ income are deducted automatically and paid directly to HMRC. This differs from a dividend payment, for instance, which is taken out of the company by the director and must be declared at the end of the tax year in a personal Self Assessment tax return.
Who counts as an employee?
One thing to bear in mind as a company director is that the UK has strict anti-avoidance legislation, which means that if you outsource work to someone, if they meet certain criteria, they are considered a de facto employee. This means that you should pay NICs on their salary. This legislation is called off-payroll working rules and commonly known as IR35 and it is important that you are familiar with the full criteria. Essentially, if you are providing someone with office space, equipment, if they hold an office and have regular working hours, they are likely to count as an employee.
As a company director, you are also an employee as soon as you begin providing services for the company (not just once you have put yourself on a payroll).
Payroll as a means to decrease your tax liability
If you are a director and shareholder of a limited company, there are two main ways to withdraw funds directly from the company; a dividend and a salary payment (you can also sell shares or take out a director’s loan). A dividend is a payout to shareholders at the end of the tax year, and comes from the company’s net profit (i.e. your total income minus your cost of sales and overheads, after corporation tax). Dividends are taxed at a lower rate than salary, as you have already paid corporation tax on your company’s profits. The tax rate on dividends is tapered, and is indicated below for 2020-2021:
- Up to £2,000 – 0%
- Basic rate – up to £50,000 – 7.5%
- Higher rate – up to £150,000 – 32.5%
- Additional rate – above £150,000 – 38.1%
Alternatively, as a director, you can set up a payroll for yourself and take a salary. Employees’ salaries are counted as a tax deductable expense. This means that if you pay yourself a salary it can help to reduce your corporation tax (your gross profit decreases and as a result you pay less tax). Income tax is also tapered and charged at the rates below:
- Personal allowance – up to £12,500 – 0%
- Basic rate – up to £50,000 – 20%
- Higher rate – up to £150,000 – 40%
- Additional rate – above £150,000 – 45%
In reality, a fairly common profit extraction strategy for most directors would be to take a small salary up to HMRC’s primary threshold, which means they are get the benefits of paying NICs, such as a qualifying year for your pension, but not paying a large amount of income tax. They would then take further income as a dividend.
Employer’s NICs vs. Employee’s NICs
National Insurance Contributions are payable by employers as well as employees. Whilst employees’ NICs are deducted automatically via PAYE, employers’ NICs are deducted separately and payable via your Government Gateway account.
In the UK, employers are obliged to pay 13.8% NICs above the secondary threshold (£169 per week). There is, however, an employment allowance worth up to £4,000. You cannot claim this allowance if there is only 1 director on the payroll.
Needless to say, it is very important that you understand your legal obligations, such as paying your employees at least the national minimum wage, as well as various other HR obligations. You are also obliged to get Employer’s Liability Insurance.
The UK recently introduced auto-enrolment legislation, meaning that if you employ someone, you are obliged to put certain staff on a workplace pension and contribute to it. This article is not intended to give up to date requirements on this topic, but we thought you should be aware. If you need more information on the subject, please feel free to get in touch.
How to set up payroll
In order to set up a payroll, you first need to register for PAYE. This is done through your Government Gateway account and is fairly easy to set up. Once you have registered, they will send you a code through the post to your registered office address which you will need to confirm in your account within two weeks.
Once you have set up PAYE, you can either get in touch with a payroll specialist to set up the payroll or, if you have less than 10 employees, you can even download HMRC Basic PAYE Tools for free if you are happy to take on the admin yourself. Once you download the software, you just have to input your data (employer & employee) and submit your payroll information on a monthly basis.
Please feel free to get in touch with any payroll-related queries and we will be happy to help.