- Salary
- Benefits in kind
- Dividends
- Pension contributions
- Rent or royalties for use of personally held assets
The most tax efficient combination of these elements will depend on the individual’s need for immediate cash, the stage they have reached in their working life, and how profitable the company is. In some cases, the business owner may choose to leave funds within the company in order to extract that value as sale proceeds subject to CGT on a subsequent disposal of the company.
This article only considers the salary element. To maximise tax efficiencies, once the optimum salary has been paid, any further profit extraction should be taken using one or more of the other elements.
Qualifying years
Paying a salary at a rate at least equal to the lower earnings limit (£6,396 per year, £533 per month) allows the individual to receive a National Insurance (NI) credit for the year, making the year a qualifying year for state pension purposes.
In order to receive any amount of the state pension a taxpayer needs to have at least ten complete qualifying years in their working life. To receive the full amount of the state pension the taxpayer needs to have accrued 35 qualifying years when they reach state retirement age. The taxpayer can view a forecast of their state pension on their personal tax account. This shows which tax years, since they reached age 16, have been qualifying years or not. Non-qualifying years can sometimes be made up by making voluntary NI contributions.
Where the salary does not exceed the primary threshold for class 1 national insurance (now £1,048 per month) the taxpayer can secure a qualifying year with no class 1 NIC payable, but the employer may have a secondary class 1 NIC liability on salary over the secondary threshold of £758 per month (£9,100 per year).
What changed in July 2022
The primary threshold for employees increased from £832 per month to £1,048 per month on 6 July 2022, (£9,880 to £12,570 per year). The other NIC thresholds were not changed for employees or employers.
As directors’ NIC is calculated on an annual earnings period, the effective annual primary class 1 NIC threshold for a director is £11,908 for 2022/23. It will be £12,750 for 2023/24 unless the NIC thresholds are changed again.
Where the owner/director is to receive just one salary payment per year the PAYE scheme needs to be registered as an annual scheme, which means calling the HMRC Employers general enquires line: 0300 200 3200. If the PAYE scheme is not registered as annual, a nil EPS will have to be submitted for every month when no payment is made. Failure to submit an EPS can result in late filing penalties.
Employment Allowance effect
Where the company is eligible to claim the Employment Allowance, that allowance will cover up to £5,000 of employer’s class 1 NIC liability for 2022/23. The optimum salary for a director in this case will be £12,570 for 2022/23, if the individual has the full amount of their personal allowance to cover it. Although the director will pay employee’s class 1 NIC of 13.25% on their salary between £11,908 and £12,570, the tax relief at 19% on the higher salary amount outweighs the NIC bill at 13.25%.
The Employment Allowance can only be claimed where the employer’s class 1 NIC bill for the previous tax year is less than £100,000 and the company has at least two employees. It is not available where the director is the only employee of the company.
If the Employment Allowance is not available the optimum salary for a director for 2022/23 is £11,908. This is because although the employer will pay class 1 NIC at 15.05% on the salary between £9,100 and £11,908, this is less than the tax relief at 19% the company benefits from on the combined salary and secondary class 1 NIC liability. The combination of employer’s and employee’s NIC (15.05% + 13.25%) on salary above £11,908 exceeds the tax relief available at 19%.