Chris Thorpe considers some of the things to consider when paying salaries.
When taken on by a business, employees obviously need to be paid, the questions are: how much; and can the business get tax relief for payments?
As well as deductions for income tax and employees’ National Insurance contributions (NICs) through PAYE, an employer must also pay NICs and (usually) pension contributions.
Tax deductions
For salaries to be deductible against the employer’s income or corporation tax liability, they must be made ‘wholly and exclusively’ for the purposes of the business. This means they must be commensurate with the employee’s duties and not excessive; any employees who are related or close to the employer might be susceptible to claims by HMRC that an element of the payments were essentially gifts, payments in the nature of family or friendship.
Any such ‘excessive’ amounts would be a disallowed expense for the employer.
National Insurance contributions
Aside from market value considerations and potentially ‘excessive’ payments, something else to bear in mind is the employer’s NICs – a cost to the employer for hiring staff.
Employers pay 13.8% NICs on salaries above the secondary threshold (£9,100 from April 2023). Employees pay NICs on salaries over £12,570 from April 2023 (which equates to the income tax personal allowance). This applies equally to directors of a limited company, who will usually pay themselves a salary and often deem the optimum salary to be the secondary threshold to ensure the company’s liabilities are at a minimum. Those directors not subject to employment contracts are not ‘workers’ according to the national minimum wage legislation, so they are able to pay themselves a small salary within the secondary threshold, irrespective of the hours worked.
NICs allowance
To assist employers with this ‘tax on jobs’, an annual NICs ‘employment allowance’ of £5,000 is available against their NICs liability.
This is not available if more than half of the business’ custom derives from the public sector or if total employers’ NICs liabilities are above £100,000. The allowance is also not available if a company’s only employee (paid more than the secondary threshold) is one of the directors.
Pension contributions
As well as paying a salary, an employer will usually pay their qualifying workers (or possibly even directors) a pension. From a tax perspective, this is a very effective form of remuneration. As well as being deductible for the employer, contributions are tax-free for the employee with no NICs, so they are very tax-efficient.
Pension contributions, likewise, must be commensurate with duties carried out and the employee is subject to an annual allowance limit of £40,000 per year (increasing to £60,000 from April 2023) – which is a gross figure and includes the employer’s contributions.
Possible alternatives
A possible option might be for employees to become shareholders or partners in the business, should that be desirable for everyone. Dividends attract not only a lower rate of income tax for the shareholder but no employers’ NICs; likewise, an equity partner is self-employed, so they will not cost the business any employers’ NICs. Share options, particularly ‘approved’ share option schemes (e.g., ‘EMI’ or ‘CSOP’), might also incentivise employees through tax reliefs and a stake in the business.
Practical tip
Where possible, salaries should be within the NICs secondary threshold for directors and employees where their hours allow it. Likewise, excessive salaries should be avoided when employing family members, so there is an optimal level, which is guided by the duties carried out and a market rate of salary. For directors, the optimal rate of salary will be the secondary NICs threshold. Pensions should be fully utilised, and where feasible or possible, other options including shares or partnership stakes, besides salary, could be considered.
