Tax rates and allowances for limited company directors

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If you are a new company director and you’re unfamiliar with Self Assessment, it is important to be aware of Income Tax and National Insurance tax rates and thresholds, dividend tax, and the way in which you can pay yourself through a limited company.

Ideally you should consult an accountant for the best professional advice and tax-saving strategies, but we’ll provide a brief overview of what you need to know to get you started.

PLEASE NOTE: The figures stated in this article apply to the 2017/18 tax year.

What is an accounting reference date for a limited company?

 

What tax does a company director pay?

Directors of limited companies are usually also shareholders. In fact, many small startup companies are one-person operations, whereby the only person who owns, manages, and works for the company is the single director employee. Whatever the set up, the following taxes may apply:

Income Tax

As a company director, you are classed as an employee for tax purposes, so you will have to register your company as an employer and operate PAYE as part of your payroll. You will be required to pay Income Tax and Class 1 National Insurance through PAYE on the wages you receive from the company.

No Income Tax will be due on the first £11,500 because this is your tax-free Personal Allowance for the 2017-18 tax year. Above that amount, you will start paying tax.

Employer’s National Insurance

The company will have to pay 13.8% Class 1 Employer’s National Insurance if your monthly income (and/or monthly wages of any other employees) is greater than £680 (£8,164/year). In such instances, where you employ no one else through the business but yourself, your company cannot claim the £3,000 Employment Allowance.

No Employer’s National Insurance is payable on the first £11,500 if your company is eligible to claim the £3,000 Employment Allowance.

Contacting HMRC when you set up a new limited company

 

Employee’s National Insurance

You will have to pay 12% Class 1 Employee’s NI on wages between the Primary Threshold (£680/month) and the Upper Earnings Limit (£3752/month).

Dividend tax

The rules on dividend tax changed at the beginning of the 2016/17 tax year on 6th April 2016. Previously, there was no tax personal tax liability on dividend income for basic rate taxpayers – dividends are paid from profits after the deduction of 19% Corporation Tax, so the company had already paid tax on this income.

As a result of these new rules, it’s not quite as tax-efficient to take a low salary and higher dividend payments through a limited company as it once was, though it is a far simpler system. The notional 10% dividend tax credit, which most people struggled to understand anyway, has been abolished and replaced with a £5,000/year tax-free dividend allowance. Above £5,000, you will have to pay varying rates of tax on dividend income received from your company:

  • 7.5% within the basic-rate tax band (up to £45,000)
  • 32.5% within the higher-rate tax band (£45,001 – £150,000)
  • 38.1% within the additional-rate tax band (above £150,000)
How to issue dividends in a company limited by shares

 

Dividend income is still paid from post-tax profits, so your company will continue to pay 19% Corporation Tax on these profits before you pay yourself dividends. The idea behind the changes is to discourage people from setting up a company simply to pay less tax, by taking most of their income as dividends rather than a wage. Instead, the government hopes to incentivise company owners to receive dividends through shares held in ISAs and pension schemes.Also, they want you to pay more tax.

Either way, you’re still better of setting up your business as a limited company, rather than operating as a sole trader. You just have to be strategic with your tax planning and remuneration, which any decent accountant or tax advisor will be able to assist you with. All being well, the government plans to reduce the rate of Corporation Tax to 18% by 2020.

Class 2 National Insurance

Whilst not applicable to directors who are not shareholders and who do not have additional income on top of their salary, it’s worth mentioning this one for clarity. Class 2 National Insurance is paid through Self Assessment by people who work for themselves, earn income that is not taxed through PAYE, and/or who do not pay Class 1 NI through PAYE.

Class 2 National Insurance is payable when you start earning above £6,025 per year. You need to pay Class 1 or Class 2 NICs to protect your entitlement to state pension and benefits, so it’s really important that you are making one of these contributions, depending on whether you are employed or self-employed.

If you receive any other form of income from the company or elsewhere (i.e. dividends from shares, a director’s loan, rental income, etc), you will have to register for Self Assessment, to report this income and pay any additional tax and National Insurance you may owe on it.

The same rule applies if you are not a PAYE employee of the company, and only receive shareholder dividends from the business. In such instances, you must register for Self Assessment, file an annual tax return to report your income, and pay any necessary dividend tax and voluntary NICs on your earnings.

About the author

James Howell

James Howell, Financial Controller and Senior Manager at Quality Company Formations, is the driving force behind the company’s financial department and is focussed on the success of the business. Throughout the growth of the business and harking back to his many years of experience in accountancy practice, dealing with all types of SMEs, he has developed a keen interest in company formation and company secretarial work. In his spare time, James is a father to 2 young children but keeps up strong interests in both music and sport.

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