Companies must operate PAYE on salaries paid to their employees/officers. This includes salaries paid to directors acting in the capacity of an officer of the company.
The basic personal allowance or ‘’free pay’’ is the amount of taxable income an individual is allowed to receive tax-free each tax year.
This tax year 6 April 2019 to 5 April 2020 this allowance is set at £12,500.00. Individuals will lose their personal tax allowance at a rate of £1 for every £2 of earnings in excess of £100,000 per tax year.
Income Tax is deducted from earnings exceeding the personal tax allowance as follows:
|Basic||£0 – £37,500||= 20%|
|Higher||£37,501 – £150,000||= 40%|
|Additional||Over £150,000||= 45%|
Tax year: 6 April 2019 to 5 April 2020
National Insurance Contributions (NIC) are paid on your earnings and benefits above a certain amount. NIC builds up your entitlement to a State Pension and other Social Security benefits. If you earn over a certain amount, your employer (your company if you are the business owner / director) must deduct Class 1 NIC from your wages through the Pay As You Earn (PAYE) system.
Your employer (your company if you are the business owner / director) also pays Class 1 Employer NIC based on your earnings and benefits above a certain level. HM Revenue & Customs (HMRC) keeps track of your contributions through your National Insurance number. This is like an account number and is unique to you. So long as you earn more than £118 (6 April 2019 to 5 April 2020) a week (£6,136 per annum) you can still build up your entitlement to a State Pension and certain other benefits. This is known as the ‘Lower Earnings Limit’.
If you are the business owner / director, paying yourself a salary above this level will mean your Company will have to register for a PAYE scheme and operate under Real Time Information (RTI). You can, however, earn up to £166 a week (£8,632 per annum) before you pay any Employee’s NIC. This is known as the ‘Primary Threshold’. Any salary paid above ‘Primary Threshold’ of £166 per week (£8,632 per annum) will incur Employee’s NIC at a rate of 12% and a further 2% on any salary paid above the ‘Upper Earnings Limit’ of £962 per week (£50,000 per annum).
Any salary paid above the ‘Secondary Threshold’ of £166 per week (£8,632 per annum) will be liable to Employer’s NIC. This is charged to the employer (your company if you are a the business owner / director) currently at a rate of 13.8%. Directors pay Income Tax on their earnings in the same way as other employees. However, NIC is worked out over an ‘Annual Earnings Period’ – from 6 April to the following 5 April rather than over the normal weekly or monthly periods that apply to employees. This is to ensure the director pays the correct amount of NIC.
Deciding How Much Salary to Pay if you are a Director
If you are a business owner/director of your own company, you are free to decide what level of salary you wish to pay yourself. By law, employees between the age of 18 – 20 years must be paid at least the National Minimum Wage (NMW) of £8.21. For employees aged 21 – 24, the National Living Wage (NLW) of £7.70 per hour applies. For employees 25 and over, the NLW of £8.21 per hour applies. Directors, however, are not employees but are officers of the company and therefore are not subject to the NMW or the NLW legislation (unless there is an employment contract in place between the company and yourself).
Since salary is subject to both PAYE and NIC and dividends are not subject to NIC, paying yourself a low salary and a higher dividend will result in maximising your income. Setting a salary of £8,632 per annum will not attract any Employer’s or Employee’s NIC or PAYE (assuming you have no previous or other income).
You should note that although perfectly legal, paying no or a low salary could increase the chances of triggering an investigation by HMRC. If this concerns you, you may decide to pay yourself the NMW/NLW (£8.21/£8.21 per hour) or higher. By way of example, for an employee 25 or over, this is £15,106 per annum if you worked 230 days at 8 hours per day.
Paying the NMW/NLW will result in a higher salary (based on a normal working week) but of course there will be a liability to PAYE and NIC, both employee and employer contributions. You may decide to be paid a level of salary higher than the NMW/NLW, which will further increase your liability to PAYE and NIC. The salary paid by the company will attract Corporation Tax relief at 19% so the decision needs to be considered carefully. When making this decision you would need to consider whether IR35 applies.
In the case of Personal Service Companies, if you are operating inside of IR35, all income from that contract, after certain allowable expenses, is subject to full PAYE and NIC. Where there is uncertainty on your IR35 status or if it applies, you should seek independent expert advice to reduce the risk of investigation, and potential penalties and interest if a future decision goes against you. It is therefore important to always assess every contract to determine your IR35 status before deciding on a salary level.
To look closer at the income tax on a director’s salary and how this is taxed for the current year 6 April 2019 to 5 April 2020 we have set out below a summary of the rates and thresholds (PAYE tax and Class 1 NIC). This should be read in conjunction with the section on Dividends as this takes a closer look at the most tax efficient way of extracting profits from the company in a tax year.
Summary of rates and thresholds (PAYE tax and Class 1 NIC thresholds)
|Rates and Thresholds|
|PAYE tax threshold||£240 per week; £1,042 per month; £12,500.00 per year (also known as personal allowance or free pay)|
|Basic||20% on annual earnings above the PAYE tax threshold and up to £37,500|
|Higher||Higher tax rate = 40% on annual earnings from £37,501 to £150,000|
|Additional||45% on annual earnings above £150,000|
Emergency tax code = 1250L W1 Wk1/Mth1
|Lower earnings limit (LEL)||£118 per week; £512 per month; £6,136 per year|
|Secondary Threshold (ST)||£166 per week; £720 per month; £8,632 per year|
|Primary Threshold (PT)||£166 per week; £719 per month; £719 per year|
|Upper earnings limit (UEL)||£962 per week; £4,167 per month; £50,000 per year|
Combined PAYE & NIC tax payable on salary: *
|up to £8,632 (PT)||0%||(Employee’s NIC of 12% + PAYE tax of 0% in this bracket)|
|above £8,632 (PT) to £12,500.00 (PAYE tax threshold)||12%||(Employee’s NIC of 12% + PAYE tax of 20% on this next bracket)|
|above £12,500.00 to £50,000 (UEL)||32%||(Employee’s NIC of 12% + PAYE tax of 20% in this bracket)|
|from £50,000 to £100,000||42%||(Employee’s NIC of 2% + PAYE tax of 40% in this bracket)|
|from £100,000 to £122,000||62%||(Employee’s NIC of 2% + PAYE tax of 60% in this bracket)|
|from £122,000 to £150,000||42%||(Employee’s NIC of 2% + PAYE tax of 40% in this bracket)|
|over £150,000||47%||(Employee’s NIC of 2% + PAYE tax of 45% in this bracket)|
There is also Employer’s NIC to pay on any salary above £8,632 (ST) of 166%. No NIC is payable on dividend income.