Jennifer Adams looks at timing and tax implications of common methods of payment of directors.
For directors, remuneration is typically assessed on an annual earnings period basis; all earnings for the tax year are considered, rather than looking at each pay period individually. This approach recognises that directors often have irregular payment patterns and bonuses rather than a set amount per month.
The payment date is broadly deemed to be:
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when earnings are credited in the company’s accounts;
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the date when the period ends where the amount of the earnings is determined before the end of the period to which they relate; or
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where the amount of the earnings is determined after the end of the period to which they relate, the date is when the amount is determined.
However, if the company enters into a service contract with the director, the terms of which make the director an employee, that director is taxed under PAYE, with the same rules as any other employee.
Bonuses
A bonus will invariably depend upon the company’s results for the previous year, with payment deemed to be:
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the same as for a salary payment;
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when a payment is made; or
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when the director becomes entitled (or has access) to the payment.
It is possible to have a bonus declared in a set of company accounts such that corporation tax relief may be claimed, but the actual payment is accrued, paid and taxable at a later date.
However, a problem can arise for the director where the actual payment date might not be for months, but PAYE will be due. A solution could be for directors to meet before the accounting year end and agree to a commitment to pay the bonus, but not determine the actual amount. This way, the amount for PAYE purposes will not be 'determined' by the end of the year.
Dividends
When a dividend is deemed to be subject to income tax in the hands of a shareholder is determined by the period in which payment becomes enforceable.
Dividends are treated as paid on the date they become ‘due and payable’, which typically aligns with the payment date, but need not necessarily do so.
The general principles for determination are:
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The resolution by the directors to pay an interim dividend does not create an enforceable debt, because the directors may revoke a decision to pay an interim dividend prior to the date of payment; therefore, an interim dividend is deemed paid when payment is made.
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In comparison, final dividends are declared at the end of the financial year and approved by the shareholders at the annual general meeting (AGM). Importantly, the payment date is the payment date specified by the company, often shortly after the AGM but need not necessarily be so. Final dividends declared with a stipulation as to date of payment, do not create an enforceable debt until that date. In comparison, final dividends without any stipulation create an immediately enforceable debt.
Doubts about the date of payment can be settled by inserting a clear statement in the company's articles of association confirming when enforceable debts are created. Minutes of directors’ meetings (or written resolutions, as applicable) should also make it clear how and when each dividend will be paid, and that the declaration creates an enforceable debt.
Practical tip
Recent tax cases have indicated that an enforceable debt cannot arise in respect of an interim dividend, and therefore the tax liability relies on the date of payment. The cases also underline the importance of written proof. While HMRC lost those cases, this does not guarantee a similar outcome in the future and, as such, should not be relied upon for tax planning.
