Tax Questions: Taking a Salary in Your Start-up
With little cash flow in year one, it may seem wise to skip on a director salary for a while, but you may be mistaken in thinking this will benefit you best.
Many founders use personal savings to fund their start-up business. If you expect it to take a year until it will be financially self-sufficient, perhaps you don’t see the point in taking a salary until then, but doing so could increase your tax bill and lessen other advantages.
Most new businesses need start-up funds. These usually come from the business owners. Where this is run through a company the two most common ways to provide funds is paying for shares in the company or lending to it and there are pros and cons to both.
Loans are more flexible and easier to get your money back from with minimal time spent on it. Plus, there are no tax consequences. When your company repays money you lent, it’s tax and NI free. If your company can’t repay you until it can afford to, you might rule out paying yourself a salary until then, but it means you will miss out on tax reliefs.
Tax and salary
For every pound of salary your company pays to you, it is entitled to Corporation Tax (CT) relief of 19p (25p in April 2023). Even where paying a salary results in the company making a loss, it can claim the CT relief against the profits or other income it generates in future. The other side of the tax coin, salary is taxable income for you and liable to NI for you and your company, but not in all circumstances. Depending on how much other income you have (perhaps none if living off savings until the new company gets going) you may not have to pay any tax on your salary and in most cases NI can be avoided too.
Say in April 2022 you and 2 ex colleagues use money from a redundancy to fund your new business. You advance the company set up, as director shareholders, £50,000 as a loan. You expect the company to start repaying in 3 months and plan to live off savings and loan repayments rather than take salaries. It would be better for each to take a salary at least equal to your tax-free allowance, £12,570 for 2022/23. With no other taxable income, ignoring small amounts of interest on savings, there would be no tax to pay on your salary, – neither you/company will have to pay NI. Also, the company receives CT relief.
While you might think the company can’t afford to pay, you might not be aware of a ‘quirk’ in the tax rules for directors…Employees are treated as receiving their salary when they get it. For directors, tax and NI are treated as salary when they are simply approved by the company, meaning cash does not have to leave the company to count as salary paid. Instead an IOU is added to the (in this example) £50,000 loans the company owes. When this is repaid it has no tax or NI consequences.
Plus where salary exceeds NI lower earnings limit (£6,396 in 2022/23) this counts towards entitlement to state pension. Paying a salary that doesn’t exceed tax-free allowances and NI threshold means your company receives corporation tax relief without a tax or NI cost. It also counts towards entitlement towards a pension. Your company doesn’t need to pay the salary; it can preserve cash by treating salary as an IOU.
For help calculating your position as a company start-up, talk to our tax specialists at LHP on Let’s Talk.