In light of the ongoing threats to business posed by the COVID-19 crisis, we’ve prepared the following guidance to assist sole traders and limited companies.
For more information on what measures are available to you now and in the future to protect you and your business, please follow one of the following two links that’s most relevant to you:
Sole traders – How to manage money risks when you’re a sole trader
Ltd companies – Managing and taking money out of your limited company
As well as updating our guidance, we’re also keeping up to date with the latest announcements over on our blog:
You may also want to keep up to date with the government’s own COVID-19 guidance and documentation via the gov.uk website
As a business owner, you'll have invested a lot of time and hard work to ensure your business can make a profit.
So, together with our friendly experts at our partner Boffix, we’ve created this handy guide to paying yourself as a business owner, together with the infographics contained within it, to show you your likely pay/salary options act a glance – and to help you make sure that, irrespective of the business model you have, you can get paid in the most efficient way possible.
How you pay yourself will depend substantially on the following factors:
• The type of business model you’re operating or planning to operate (e.g. limited company, sole trader, partnership)
• Whether you’re generating profit already (relevant to limited companies)
• Whether you’re a sole owner-director, or you have fellow directors already (relevant to limited companies)
This is an area that's heavily directed by the UK’s tax rules, and they can be quite detailed and nuanced at times.
The infographic below summarises the first stage of the landscape.
Then we’ll go on to examine the rules that typically affect each of the relevant business models and the pay options available in relation to them.
Before we go on... just a quick point to remember your student loan and your plan of repayment – as it will still need to be repaid.
How business models affect pay for business owners
Ok, so now lets examine this landscape in a bit more detail.
Use the headings on the left side of this guide to skip between our explanations on each business model if you're interested in some models more than others.
How to pay yourself as a sole trader
The UK’s tax regime treats sole traders in a similar way to employees.
Revenue generated by their business activities is treated as personal income and therefore subject to payment of income tax and National Insurance contributions (NICs).
There are no different or additional allowances to reflect these business activities. There are also fewer tax reliefs for which sole traders can apply.
Take a look at our guide to tax for the self-employed for more information on how the tax regime works for sole traders and what you need to do – especially if you’re just starting out.
How to pay yourself as a director of a limited company
There’s a difference between:
- sole or founder directors: who are the only owner-directors of their limited companies and
- businesses that have started (or progressed) to engage multiple directors, usually (and often unavoidably, given the UK’s employment law) as employees of the business
Many small businesses start out with one owner-director and then grow to take on more directors, who will probably be engaged as employees under director service contracts from the outset.
So, it’s quite possible that you may start out enjoying some pay and tax benefits as a single owner-director that you later have to forego as you take on fellow directors and/or more shareholders.
You’ll need to keep this position in mind as you grow – to ensure that you don’t inadvertently fall foul of the tax rules when you start to hire in others, and so that you stay on top of your profit calculations.
Here’s a quick infographical overview of the pay option landscape relevant to directors of limited companies.
Pay options for directors of limited companies
We've summarised some further detail about each of these approaches below
Sole owner-directors of limited companies
You have a couple of options here...
The first has traditionally been the more financially attractive option, given the tax allowances that have been available. And many freelancers still choose this approach, setting up their businesses to capitalise on the benefits that profit-making consultancy or other services can generate.
These favourable allowances, however, have been dwindling in value over the past few years and HMRC looks set to continue this trend.
So, it's worth taking the time to weigh up both approaches carefully, as the first option may end up being not that much better than the second. But it's also heavily dependent on your business making a profit – as if you’re not making a profit, option 1 won't be appropriate.
Option 1: Paying yourself a small salary and taking a dividend (if you're in profit)
If you’re making a profit, this may be a good starting point option for you as a sole director of your limited company.
You could take a small salary – the ideal approach here is to keep that salary to the personal tax and NIC allowance threshold and not exceed it. The threshold is currently £9,500 – check here for updates.
Then you could take out any additional amounts from the company in the form of a dividend, rather than a salary. These will typically be paid out less frequently, although they can be withdrawn on a regular basis, provided that the company remains in profit.
NICs are not payable on dividends (unlike salaries).
This can be a significant financial benefit since currently, 13.8% NIC is payable by employers to HMRC on any salary that exceeds £183 per week.
The employee additionally pays 12% on that same amount. Check the latest NIC rates here
The way that dividends work is:
they can only be paid out of profits after tax has been paid, and
the same level of dividend must be paid to all shareholders holding the same class of shares – unless you have expressly contracted exceptions to this.
(Exceptions such as this are not common in early-stage businesses).
Directors are also duty bound to manage the business responsibly and transparently. Taking a lot of money out of the business may been seen as irresponsible. However, if you’re the sole director and sole-shareholder, you may not have anyone to answer to.
But if you do have other shareholders, there may be limitations within your company’s shareholder agreements or your company’s operational rule book, captured officially in your articles of association, on what can be paid to you as a sole director, and how dividends or other payments, like loans to that director, can lawfully be provided.
Also, beware that tax is also payable on dividends, albeit at a lower rate – you can find out more about this on the government website – but in short, it works together with your income tax band.
What if you're not in profit?
The law does not allow you to pay yourself a dividend if you’re not making a profit. So you’ll need to consider option 2 instead.
Option 2: Paying yourself as an employee through PAYE
Paying yourself a ‘living wage’ as an employee is an option that some business owners take – and in the early stages of being a startup (where there is no profit coming in to the business to permit a dividend), it may be the only choice.
PAYE tax rates
Different PAYE income bands and their tax rates
You can check for the latest tax rates here
National Insurance Contributions (NICs) are also payable on top of this and the table below explains the different thresholds
National Insurance Contribution rates
Check out the latest NIC rates here
If you're a small company employing people ( i.e. yourself), you can claim up to £4,000 a year in employers' NICs allowance. Eligibility for this relief is available to your business if you have paid less than £100,000 in employers’ NICs in the previous tax year.
But remember: the employee rate of 12% will still apply and if you're an employee, you'll still be legally obliged to pay this (through the usual monthly deductions from their salaries).
So, if you’re earning at the top rate of income tax, you could end up paying 45% of your salary in taxes.
And that’s a big hit – especially in the early days of getting your business off the ground. Even if you’re not hitting the top-rate threshold, it’s still a lot of money going to HMRC.
Of course, the smaller the salary you take, the smaller the tax liability is. But we all need to survive on something!
Here’s a quick infographic setting out your options:
The above infographic shows that:
Keeping your salary below the current threshold of £9,500 will result in no PAYE or NICs being payable by you.
If you do have employees, then you may be able to apply for what's called the Employment Allowance, which enables eligible businesses (one criterion being that you have employees), to reclaim up to £4,000 in employer’s NICs.
This means that you could pay yourself a bigger directors salary of £12,500, and this would be a bigger offset against your corporation tax liability than a £9,500 salary.
Don't forget about pensions either
If you’re an employee, and you have other employees in your business, you may have to pay yourself a pension.
UK law requires all employees to be auto-enrolled in a pension scheme, which pays a legally-dictated minimum pension contribution on behalf of each employee each month.
Your eligibility for the state pension is also relevant here. You can pay yourself a wage as a director and qualify for a state pension – provided that you keep your salary above a prescribed level of pay as, otherwise, your entitlement may be affected.
You can check the relevant threshold here
These are generally the same as the NIC thresholds and you can access a personal pension statement by registering with HMRC.
It’s best to take advice on this, but you can find out a little more on directors and the state pension here
If you’re interested in your pensions obligations for employees, our guide: Pensions 101: for when you’re starting out as an employer will help you get started.
Companies with multiple directors
You may start with several co-founders of your business
If so, its not unusual that each of them will become a statutory director of the limited company from the outset.
Statutory directors are those who are legally and officially recognised as directors on the company’s official register of directors, required by the UK’s registrar of companies, Companies House.
To find out more on what it means to be a statutory director, check out our guide on directors’ duties and liabilities
If this is the case, or if you’re a sole director who has now engaged one or more other directors, you’ll need to follow the approach to salaries and benefits below instead.
Once you have more than one director or employee within the business, you are legally bound to treat them as an employee – and this means that:
• Your company will need to pay employer’s tax and NICs in relation to them
• The employee will be liable for employee’s income tax and NICs and they may well have to pay additional tax on any benefits (e.g. health insurance or a company car) that you provide to them.
This can add quite a financial burden to your business, especially since you must pay all employees the National Minimum Wage, currently £8.72 depending on age per hour.
You can check for updates on this threshold here
So, whenever you factor in the cost of taking on a new employee, always ensure that you budget for their gross salary, plus the cost of any benefits and tax liabilities, (as well as your mandatory obligations to set up and pay into a pension scheme for your employees).
For more guidance on whether you can afford an employee, see our separate guide on this topic.
This helps you to calculate all of the related costs of hiring someone, and suggests alternatives that you may wish to consider before you make that final hiring decision and start recruiting.
What does the employer pay?
As a limited company employing someone, you’ll pay employer NICs for your employees at a current rate of 13.8% on salaries paid in excess of £183 per week.
Check for updates on this rate here
Its good to remember at this stage that there is the NIC employers allowance of £4,000 per year.
And of course, you’ll need to pay NICs on certain benefits that you provide to your employees, (see further below), as well as minimum pension contributions under the auto-enrolment regime, unless an employee has freely opted out of this of their own volition.
See our guide: Pensions 101: for when you’re starting out as an employer, for more details on your specific pension obligations towards your employees
What does the employee pay?
The employee pays income tax and NICs on their gross salary.
This is due monthly, via the government's Pay-As-You-Earn (PAYE) system.
As their employer, you'll be legally responsible for deducting the amounts due to HMRC before paying the net salary entitlement into the employee's designated bank account.
The employee may be required by HMRC to make annual tax returns confirming their tax position. They'll use a form called a P60, which summarises the tax that you have collected and paid on their behalf, as well as details of their gross and net salary.
This is a compulsory form that needs to be given to the employee after the end of tax year by the 31 May.
You may also need to supply the employee with a separate form called a P11D form, which:
- Summarises any additional benefits of value that you provide to them – in case any additional tax is payable on these
- The amount paid as a benefit would need to be included on the monthly payroll (beware that these qualify for National Insurance)
- P11D forms need to be submitted to HMRC by 6th July following the end of the tax year and any tax due should be paid by 22nd July
The employee will be responsible for paying any surplus tax, though they may be unhappy that this has not been deducted by you during the course of the year.
The easiest way to manage the salary and tax aspects of this position is to use a good payroll software solution and/or to engage someone with good accounting skills to help you.
It’s often the most time- and cost-efficient way of staying on top of the tax obligations and to keep staff, at all levels of seniority, happy to be working for you.
The investor/shareholder perspective
Whether you’re a sole director or you run a business that has several directors, it’s advisable to fix salaries at sensible levels – particularly if you have ambitions to bring on board investors.
Investors will expect you, if you’re the founder director, especially, to take only a very modest salary in the early days of establishing and running your business.
They will want their money to go towards funding growth activities and bringing on board other talent, although they will also want you to remain incentivised, and so will generally be amenable to you earning a salary or taking a dividend (if relevant) that is reasonable.
What’s ‘reasonable’ here will generally be judged by the stage at which the business is at – and crucially, what revenue it's generating and/or it’s imminent revenue-generation potential.
Other tax requirements/benefits worth a mention
There are some other benefits and/or taxable elements of your overall financial package arrangements that shouldn’t be overlooked:
Healthcare, life insurance and company car allowances:
If you’re receiving other benefits, you may find that these alter your tax position and as an individual, you need to pay income tax on these also.
Healthcare and life insurance are taxable benefits
With a company car, both you and the company will need to pay NICs on it, the company at 13.8% and you at 12% currently. The benefit will need to be declared to HMRC on the P11D form that the company must produce and you will then need to disclose this and pay any money due on your income tax return
If you own the car in your personal capacity, you don’t need to pay this. And you can charge the business for your fuel costs, and these repaid expenses are not counted as income, neither are they taxable
- This is no longer an option with new schemes closed from October 2018
- If you have an existing scheme (before 4th October 2018) or want to find out more about it, then visit the government website here
R&D tax credits
The good news is that while dividends do not attract research and development (R&D) tax relief, salaries do (including those of directors). So while you will have to pay PAYE and NIC on these salaries, you can reclaim some of those costs in R&D tax relief, if your business is eligible for it.
See our guide to what you need to know about R&D Tax credits for more information on this kind of tax relief and when it’s available.
Loans to directors
This is another way that directors may extract funds from their limited company on a short-term basis.
It can be a fast way to get access to money – but even if you’re a sole director and sole shareholder, you’ll still need to act lawfully in putting a loan arrangement in place.
You’ll need to establish a separate bank account for your company, calling it a director’s loan account and this is the account to which you’ll need to pay back the money loaned.
Income tax may be payable by you, as a director, on this loan, depending on the amount of the loan and if interest was payable at less than the official interest rate – which you can find here
From the government's point of view – if your loan is £10,000 or more, the loan will be treated as a 'benefit in kind’ by your company.
This means that:
- NI will be deducted
- You'll also need to report the loan in your personal tax return
- Your company may also need to pay corporation tax on the loan – but the good news is this can often be reclaimed. You can find out more here
Want to access this guide?
Already have a Farillio account? SIGN IN
Get unlimited access to 100s of legal resources by signing up to Farillio today.
- Manage your legal documents online
- Well written legal templates by our partners
- Guides to help you understand law
- Legal help available every step of the way