Beware Directors who continue to draw down more money than their salaries or dividends allow.
The real sting is not so immediately obvious, but it will affect those directors who continue to draw down more money from their company each month than the RTI-reported salary, expenses and available declared dividends provide for. Continuing to do this against good tax planning advice is just going to precipitate a higher tax bill when the year end accounts are prepared.
The company will face a 25-35% surcharge to Corporation Tax for any loans made to a director in the year if the amount has not been fully repaid within nine months of the tax reporting date. The extra tax paid can be reclaimed back from the HMRC when the director’s loan has been repaid, but as it can take over a year to receive the refund, such surcharges can often be a disaster as far as business cash flow is concerned.
The need to consider the tax implications of a director’s loan often only materialises when the year-end accounts are prepared and it is discovered there is insufficient distributable profits to cover the withdrawals made. To make matters worse, we often find the company cannot afford to pay the extra tax on an overdrawn director’s loan account, nor can they afford to pass the required bonus as a salary after the event and before the expiry of the nine months’ limit to clear it. The only other remaining option available is the director to repay the overdrawn amount back to the company from private funds.
The new and worrying dimension to the director’s loan question will arise where a director has created the loan by regularly making a series of withdrawals each month from the company’s bank account for private expenditure that cannot be supported by the salary and legitimate dividends declared. The Companies Act now allows companies to vote through a loan to a director and a properly convened meeting that is duly minuted and recorded in the company’s records. That is not the same as a situation where the director just uses the company’s bank account as an extension of his own private bank.
HMRC will want to charge Tax and NI on private payments.
The issue here is that the HMRC will be fully justified in viewing these private payments as distributions subject to PAYE/NI. There is nothing new in that treatment, but the profession is waiting to see how the HMRC will apply the penalties to what will be false accounting by the employer under the RTI rules if there are grounds the employer should have realised that the salary and dividends they were presumably voting through were insufficient to cover the actual withdrawals being made.
The point we hope directors of small companies take on board is they can no longer declare monthly dividends on a wing and a prayer to cover the money they withdraw from the company each month. Every dividend declared must be covered by a signed minute approving the dividend with due regard to making sure the company has the distributable reserves to support it. If companies and directors do not take enough care over how they extract their profits from their company, then RTI may just come back and give them one hell of a headache over the next few years.
It costs nothing to talk.
We consider the HMRC’s introduction of RTI payroll reporting a step in the right direction. Especially as it is making a huge contribution to stopping benefit fraud, which was one of the main reasons it was introduced in the first place.
If you would like to discuss your payroll position, please take advantage of our free first consultation. You can either do this over the telephone or we can arrange a no-obligation and free appointment. Call us on 01737 551904.
Director's salary - considerations
What is the optimum pay to take as a director?
The answer to that question is one often asked of accountants and the answer is simple. You just have to work through the options that might influence the decision. In most cases a director’s pay is determined by simple market forces.
The optimum pay question only arises when a director has the choice to vary the mix of salary and dividends they take with a view to minimising the tax they and their company pay. In recent years, many directors have paid themselves minimal salaries equaling their personal tax allowance and then take out the rest of their company’s available profits by dividend to avoid paying National Insurance. That major tax advantage was curtailed, but not completely eroded, with the introduction of the new personal dividend tax on 6th April 2016. In future, taxpayers will pay extra tax on the dividends received after the first £5,000. The extra tax will be assessed at 7.5% for basic rate tax payers, and 32.5% for higher rate tax payers.
This table 2016-17_Tax_comparison for directors confirms that a director will still save a hefty £4,719 in tax by extracting a typical £50,000 of available profits by dividend as opposed to salary. The tax saving differential reduces to only £3,127 if the Employment Allowance of £3,000 is added into the mix. So, whilst the new dividend tax may have reduced the tax advantage to be gained by choosing a low salary and voting through higher dividends, it has not completely eroded the benefit of continuing with that option.
So, we will stick with the premise that small company directors will still favour taking relatively lower salaries and higher dividends. We just need to look at what factors may affect the level of salary chosen.
Factor 1: The new National Living Wage (NLW).
The mandatory National Living wage requires all employees aged 25 and above to be paid a minimum of £7.20 a hour (£7.50 from April 2017). This will mean most directors working a standard 35-hour week should be paid a salary of at least £13,104 a year. This is £2,104 higher than the optimal tax saving salary of £11,000 that would otherwise be recommended if the Employers Allowance can be taken advantage of in 2016-17. Unfortunately, a change in the last budget removed the option to claim the Employers Allowance in single employee companies from this year.
Although the HMRC have certainly rattled the cage bars in the past, the HMRC rarely seem to challenge directors who pay themselves well below the Minimum National Wage rate. We suspect the current national debate on the morality of tax payers ‘legally’ minimising their tax liability is effectively handing a popular mandate to the HMRC to be much more aggressive in applying the Laws that do exist. It would not surprise me if the HMRC were to have a pop at those directors that continue to claim a salary lower than the NLW when their accounts suggest they are working more hours than the rate would allow. Of course, the NLW will be the lever that opens the enquiry, but it would be a very optimistic taxpayer who assumes the HMRC’s interest in their tax affairs will start and stop there.
Currently our understanding is that if the director does not have a contract of employment the NLW rules do not apply.
Factor 2: Working under the shadow of IR35.
The new personal dividend tax has done exactly what it was intended to do. It is now much less attractive to incorporate to take advantage of the tax breaks that previously existed. Of course, most contractors must incorporate to be considered for work. So, the tax treatment is very much a secondary consideration.
That said, now is the time for directors of personal service companies that undertake contracts that might fall within the scope of IR35 to change their strategy on profit extraction. It is time to start paying yourself a higher and more commercially realistic salary now that the tax advantage of taking dividends has been significantly reduced.
HMRC apparent focus is on the question of client ‘control’ of the contractor to determine IR35 status. Reduced to its simplest form, if the client has day-to-day control so that they can decide what tasks the contractor will works on – then IR35 will probably apply. If the contractor is taken on to fulfil a distinct project and the contractor controls how the work is carried out – then IR35 would most likely not apply.
If the contract is so grey and uncertain, there is now a strong argument for directors to cut the risk they are running of being caught out and settle for a higher salary and lower dividends mix. The higher salary will serve to mitigate the outcome of an adverse IR35 tax investigation should you be unlucky enough to suffer one, and there is the always the argument that by paying a higher salary you reduce the chances you will be selected for an IR35 investigation in the first place.
Factor 3 – The Mortgage Angle.
If it is likely you will be applying for a mortgage in the next three years, you may wish to maximise your salary at the expense of taking smaller dividends. You will need to talk to a mortgage adviser who can advise you on what mix of salary to dividends lenders are currently looking for. It does seem to us, however, that lenders are much more likely to lend more at a favourable rate to directors with a history of high salaries topped off with small dividends rather than the reverse.
Factor 4: Companies with directors who contribute more than others.
It is perfectly normal to find a small business where some of the directors work longer hours and contribute far more to the profitability of the company than others. In such circumstances, it is only fair that those who work the hardest should be rewarded for the extra contribution they make to the success of the business. If the directors decide to extract the profits by dividends, everyone tends to agree to the principle of reward for endeavour until it comes to the point where they must agree how the profits are actually to be shared out. Then the bun fight, sadly, commences.
If you have a company where directors work different hours, then it is often better to agree a unified hourly rate and then pay a salary each month based on the number of hours each director worked. Residual profits can then accumulate and be shared out on an equal basis periodically. This way the level of remuneration attributable to endeavour is taken at a time when everyone can better relate to the work put in by each individual. Delay the point at which all the profits are shared out by dividend alone for any length of time and people start forgetting or will even challenge who did what.
Of course, saving tax is not always the best deciding factor for choosing your salary level. If you are looking for some free advice on how to plan your remuneration package, then call Mike Devine on 01737 551904.
What is the most tax efficient Director's salary for 2017/18?
For historic reasons we have an income tax threshold (personal allowance £11,500 2017/18) and a lower national insurance (NI) threshold (£8,164).
One man companies.
If there is only one director/employee the company is not entitled to the NI Employment Allowance and in these circumstances the salary should be restricted to the NI threshold ££8,164.
Husband and wife companies and other companies where the NI liability is less than the Employer Allowance £3,000.
If the company qualifies for the Employment Allowance NIC reduction and where the directors/employees have no other income then £11,500 is often the optimum salary. At this rate, there is no tax but a small amount of employee’s NI. The director/employee will however receive a full year’s NI credit for state pension records. The company can claim the salary against its corporation tax profits. For a husband and wife company where one spouse does most if the work (ie one spouse provides on site consultancy) the salary to the other must be paid on a commercial basis. Also we recommend that the salary is actually paid (set up a monthly transfer from the company account to the personal accounts of the director/employee). If you are using bookkeeping software you should be able to set up a memorised transaction for this.
Companies with a number of employees.
For many directors the most tax efficient salary for 2017/18 is £8,164. This is on the basis that the Employment Allowance NIC break is being fully taken up by the business’s other employees. As a result, if the director has no other income, there will be unused income tax allowances of £3,336 (£11,500-£8,164). This will be used against dividends but these are only taxed at 7.5% In these circumstances, consider utilising these allowances by taking a benefit in kind from the company. The company will get a full deduction for the cost (i.e. it is part of the director’s remuneration package) and the company will only have to pay employer’s NI on this. There will be no tax due on the director to the extent of the first £3.336 of benefit
Keeping track of transactions of directors - Bookkeeping.
Most bookkeeping systems will use a “Director’s current account” (DCA). If this is in deficit
(debit) it may be referred to as the “Director’s loan account”. Where the director has a capital investment in the company it might be called the“Director’s capital account”. Essentially, for bookkeeping purposes, they areall the same thing.
You don’t have to use a DCA if you draw salary, dividends etc when the transaction happens. For example, if there is a dividend paid of say £5,000 the entries will be pay £5,000 (credit) from the bank to the director/shareholder. The other side of the transaction (the debit) will be to record this as a dividend paid.
For most companies however, the transactions will not be covered immediately. For example, the director may start the company by opening a company bank account with a deposit of say £1,000 so the DCA will be in credit by £5,000. Various business transactions then go through the company bank account some of which may be director’s drawings. If the director takes a £1,000 per month the DCA will be in deficit by £7,000 and there are tax implications (see excess drawings). To avoid this adjustments salary, dividends or reimbursed expenses need to be made.
The DCA is a quite a complicated concept to understand from a theoretical point of view. We will set up the DCA within your bookkeeping system but you do need to keep an eye on it and ensure it remains in credit. Once you can see the transactions making up the balance it will be much easierto understand.
Expenses and benefits in kind for Directors
There is no relief available on the cost of home-to-work travel unless it is to a temporary workplace, or home is a workplace. Directors perform many different duties so whether a home qualifies as a workplace in relation to an individual director will depend on the facts of each case.
When a director has to travel between different sites or appointments etc the cost of travel and incidental costs (subsistence, accommodation and incidental overnight costs) will also qualify for tax relief.
The cost of some triangular travel where the journey is from home via a temporary workplace may be allowable.
Where an employer provides a higher paid employee, or a director with a company car, a taxable benefit arises. The amount of the benefit is determined by the cost, CO2 emissions and power supply, The benefit is reduced when a vehicle is not made available for part of the tax year.
Pooled cars can be provided tax-free while the charge on low emission vehicles can be very low.
A further benefit arises if fuel is supplied for private use. It is unlikely to be tax efficient to supply private fuel.
Car benefit is calculated as a percentage of the manufacturer’s list price of the car plus accessories, based on the carbon dioxide (CO2) emissions of the car as follows:
Take the list price of the car.
Add the price of any accessories.
Deduct any capital contributions made by the employee toward the cost of the car or accessories. This is the “interim sum”.
Multiply the interim sum by theappropriate percentage (this is worked out according to the car’s CO2 emissions with adjustments for fuel type).
Reduce for periods when the car is unavailable or shared
Deduct payments made* by the employee for private use of the car.
If the car is a classic car with a market value of more than £15,000 the rules are changed.
There are special rules for cars that have very low emissions/run on dual/alternative fuels.
The appropriate percentage changes each year.
The employer pays Class 1A NICs too, but this along with all the running costs and capital allowances, are tax deductible.
The Revenue’s company car and fuel benefit calculator can be accessed here.
Buying or leasing
For a cash purchase the company can claim capital allowances based on CO2 emissions. If HP is used a similar deduction is available and the finance costs can be claimed. For an operating lease the rental payments can be claimed subject to a possible restriction depending on CO2. For some qualifying cars 50% of the VAT can be claimed.