Whilst sole traders generally pay themselves directly out of any business profits, there are more options available to the owners of limited companies. This creates greater opportunities for tax efficiency and planning.
As well as being able to pay themselves like employees through PAYE, a company shareholder (who may also be the sole director and owner, particularly in smaller companies) can also, or alternatively, draw dividends.
Furthermore, directors’ loans are available, as are a variety of employee expenses, all of which can go towards an overall ‘package’ of benefits.
Taking a salary from a limited company
Company owners of SMEs will often be directors as well as employees. Just as any other employee in the business, company directors can draw a regular monthly salary through the Pay As You Earn (PAYE) system.
Salaries are counted as allowable business expenses, so the payment of salaries has the effect of reducing the amount of corporation tax payable. However, paying a high salary can be less tax efficient than drawing dividends.
Registering for PAYE
If you have not done so, company directors must first register as an employer with HM Revenue and Customs (HMRC) to draw a salary. This is the case even if there is just a single director who also owns the company.
PAYE registration should generally take place before the first payment, and not more than two months before this first payment.
What taxes need to be paid under PAYE?
Salaried directors will be taxed at source, through the PAYE system, just as any other employee. Income tax and National Insurance Contributions (NICs) must be deducted, along with additional employer’s NICs, and paid to HMRC.
Some directors opt to limit their salaries to the NIC threshold, or the personal allowance (i.e. income tax threshold), and to draw further payments via dividends, for the purposes of tax efficiency.
Claiming expenses and benefits from a limited company
Some business owners will decide to make substantial use of expenses and benefits, as an addition or alternative to salary and dividends. There are a whole variety of expenses and benefits which may be claimed by company directors, including but not limited to:
- Pension and retirement benefits schemes
- Computers and office equipment
- Training costs
- Company cars
- Fuel expenses and parking charges
- Medical insurance
- Travel expenses, meals and entertainment costs
What tax needs to be paid on expenses?
Each type of expense or benefit is subject to a different amount of tax and some are tax free (e.g. certain childcare expenses*). Taxes on employee benefits should be reported to HMRC where necessary and paid accordingly under PAYE.
How is tax paid on expenses?
Taxes on expenses can be paid as part of the PAYE system, on a monthly basis, together with the payment of salaries.
Additionally, employers must send HMRC details of any expenses and benefits which have been provided to employees or company directors (and their family or household), in the form of an end-of-year expenses and benefits report.
Record keeping of expenses and benefits.
It is vital that full records of any benefits and expenses paid to directors and employees are retained for 3 years from the end of the tax year to which they related.
HMRC may request to see these records as part of an inspection. Records retained should include:
- date and details of every expense or benefit which has been provided
- any information needed to work out the amounts which appeared on end-of-year (P11D) forms • any payment contributed by directors or employees to an expense or benefit
Any correspondence with HMRC in relation to benefits and expenses should also be retained.
Drawing dividends from a limited company
SMEs often have a single shareholder who also acts as sole director and essentially owns and controls the entire company.
What is a dividend?
A dividend is essentially a payment made to company shareholders out of profits. They generally need to be made equally to all shareholders, on the basis of the proportion of shares held.
Dividend payments cannot exceed company profits from current and previous financial years.
How are dividends paid out?
A directors’ meeting must be held to ‘declare’ the dividend payment and minutes of the meeting must be retained – even in the case of a sole director.
In respect of each dividend payment made, a dividend voucher must be written up and include:
- the company name
- date of dividend payment
- names of shareholder(s) being paid a dividend
- the total amount of dividend being paid out