What You Didn't Know About Paying Yourself as a Company Director Most people who start a business would assume that the best way to do this is by simply taking a salary out of the business. However, there are several reasons why this isn't always the case.

So, you have started your own company which is now doing so well that you're looking to take money out and pay yourself. It's a great situation to be in. Most people who start a business would assume that the best way to do this is by simply taking a salary out of the business. However, there are several reasons why this isn't always the case.

There are two ways in which a company director can pay themselves; a director's salary and dividends, but what's the difference and why would you use both?

What is a director's salary?

A director's salary is the same as a normal employee's salary; it's taken out of the company's gross profit before the business pays corporation tax. The benefit of this is that it will reduce the company's corporation tax bill, but it will have to be processed in the same way as an employee's salary would through PAYE payroll. This means it would be subject to income tax, National Insurance Contribution (NIC), and pension contributions unless you opt out.

Income tax varies depending on your level of earnings and is split into the following bands, as set out on UK's Government website:

Band Taxable income Tax rate

Personal Allowance Up to £12,500 0%

Basic rate £12,501 to £50,000 20%

Higher rate £50,001 to £150,000 40%

Additional rate Over £150,000 45%

You will also have to pay a personal and company National Insurance Contribution dependant on the salary you take, at 13.8% for the company and the following levels for the personal contribution (Correct for the 2020/21 tax year):

Your pay Class 1 National Insurance rate

£183 to £962 a week (£792 to £4,167 a month) 12%

Over £962 a week (£4,167 a month) 2%

A director's salary will also have to include a pension contribution from both the company and the employee (in this case, yourself) to meet the minimum pension contribution outlined by the Government below. However, it is worth noting that you can opt out of the pension contribution should you wish.

The minimum your employer pays You pay Total minimum contribution

From April 2019 3% 5% 8%

As a result, paying yourself through a PAYE salary can be useful as you can make use of the £12,500 tax free personal allowance but if you are going to be in the higher or additional rate tax band, then taking a dividend payment can be a more tax efficient solution.

What are dividends?

Dividends are when a company makes a payment to the shareholders by distributing the post-tax profits of the company. This means that to take a dividend, your company needs to make a healthy net profit after you have paid all expenses and Corporation Tax. The benefit of dividend payments is that they are not subject to PAYE income tax but instead have a different tax rate which is lower.

When you receive dividends, you will not be taxed on anything under the £12,500 personal allowance assuming you have no other income. You also get an additional £2,000 tax-free dividend allowance on top of the £12,500 personal allowance. After the tax-free allowances have been exhausted, the following tax bands apply to dividend payments:

Tax band Tax rate on dividends over the allowance

Basic rate 7.5%

Higher rate 32.5%

Additional rate 38.1%

As you can see, the relative income tax rate on dividend payments is lower than the PAYE income tax for the corresponding band. This means that it can be more tax efficient to take some of your income in the form of a dividend rather than a salary, assuming the business is profitable enough.

Why would I not just take dividends then?

After reading that you may be asking yourself why you wouldn't just take dividends instead of taking a salary as part of your income. There are two main reasons why:

Taking the minimum salary will mean you are still paying into your state pension. If you don't take a salary, you will not be making sufficient national insurance contributions to be eligible for state pension. For this reason, it is advised to take a salary of £8,632 and then take dividends for the rest of your income. This will mean that the salary is within the National Insurance Primary Threshold, so you won't have to pay a NIC, but it is sufficient to accrue a state pension. The optimum salary will change slightly if you have other employees in your company due to the "Employment Allowance', for a full break down check out the article I wrote which explains the maths for the best way to pay yourself depending on your exact situation.

Taking a salary will reduce the company's corporation tax bill. When a company pays a salary to an employee, its' value will then be deducted from the gross profit and then the total amount of corporation tax the company has to pay at the end of the financial year. This means that, by paying yourself a salary, you can reduce the amount of corporation tax your business will pay, without having to pay any income tax, assuming you stay under the £12,500 personal allowance.

R&D tax credits: Do they affect me?

There's always a spanner, isn't there? R&D tax credits are valuable relief that your company can recover from the government, if any activity that your company undertakes, is looking to solve some form of fundamental uncertainty within your industry. A large bulk of the claims tend to be based on a percentage of labour spend. So, if this is the case, it may well be a compelling argument to pay yourself the higher salary and take less dividends.

Furthermore, legislation is in the pipeline to cap R&D credits based on three times a company's total PAYE & NIC liabilities for a financial year; so, the larger the salaries, the higher the credit.

In summary, paying yourself as a Director doesn't have to be complicated but with a little bit of knowledge, it's possible to save yourself and your company thousands in tax every year. If you're still unsure how much to actually pay yourself, check out this useful article on paying yourself from startup and beyond.