A salary has important benefits for any remuneration strategy.
A salary is a payment made by a company to its employees, as compensation for their time. Salaries paid are subject to income tax and National Insurance Contributions (NICs), which are deducted from salaries and paid to HMRC via a Pay As You Earn (PAYE) scheme.
Employees pay income tax at their marginal rates of tax (after deducting their personal allowance) and NICs on salaries over the Primary Threshold. If an employee is paid a salary over the Lower Earnings Limit then the tax year is a qualifying year for the state pension.
The employer also pays NICs on the gross salary paid to the employee over the Secondary Threshold.
Although the tax rates on salaries are higher than those on dividends, salaries have important benefits for any remuneration strategy for an owner-managed business:
- Salaries count as earnings, unlike dividends, therefore can affect the maximum pension contributions that a taxpayer can make in a year.
- Companies receive a tax deduction for the gross salary and Employer’s NICs paid, but not for dividends. Depending on other income, owner-managers can therefore take a salary, saving corporation tax, whilst paying no income tax or NICs, saving tax compared to a dividend-only strategy.
- Salaries can be paid when a company does not have distributable profits, whereas dividends cannot.
It should also be noted that directors, whilst still being classed as employees, can often be treated separately due to their status and involvement with management of the company. Where the director is an “office-holder” and there is no written contract of employment (as is often the case with Owner-Managers) then there is no requirement to meet National Minimum Wage (NMW) regulations for tax purposes (however this is still required for Tax Credits purposes).