You’ve used your personal savings to fund a start-up. You expect it to take a year until it will be financially self-sufficient. You can’t see the point of taking a salary from the company until then, but might you be losing tax and other advantages?
Start-up funding
Most new businesses need start-up funds. These usually come from the business owners. Where this is run through a company the two most common ways to provide the funds is by paying for shares in the company or lending to it. There are pros and cons to both but loans are more flexible because it’s easier to get your money back with minimal fuss and admin. What’s more, there are no tax consequences.
Tip. When your company repays money you have lent it’s tax and NI free.
Trap. Your company won’t be able to repay you until it can afford to. This seems to rule out paying you a salary until then, but it means you’ll miss out on tax reliefs.
Tax and salary
For every pound of salary your company pays you it’s entitled to corporation tax (CT) relief of 19p (19% is the current CT rate, but this will increase to 25% in April 2023). Even where paying a salary results in the company making a loss, it can claim the CT relief against the profits or other income it generates in future. The other side of the tax coin is that salary is taxable income for you and is liable to NI for you and your company, but not in all circumstances. Depending on how much other income you have (you might have none if you’re living off savings until the new company gets going) you may not have to pay any tax on your salary and in most cases NI can be avoided too.
Example. In April 2022 Sarah and two former colleagues have used money they received from their redundancy to fund a new business. They’ve each advanced the company they set up, of which they are the director shareholders, £50,000 as a loan. They expect the company will be able to start repaying this in three months. For the next year they will live off their savings and the loan repayments. They therefore don’t plan to take salaries. This is a poor tax strategy.
Tip. Sarah and her colleagues should each take a salary at least equal to their tax-free allowance, £12,570 for 2022/23. As they have no other taxable income, ignoring the small amounts of interest they get on their savings, there would be no tax to pay on their salary, neither would they or their company have to pay NI. What’s more, the company receives CT relief. Although Sarah thinks that the company can’t afford to pay them, she isn’t aware of a quirk in the tax rules for directors.
Tip. While employees are treated as receiving their salary when they get it, the position is different for directors. For tax and NI purposes they are treated as receiving salary when it’s approved by the company. In other words, cash doesn’t have to leave the company’s coffers for it to count as salary paid. Instead, it’s an IOU which for Sarah and her friends is added to the £50,000 the company already owes each of them. As we’ve already mentioned, when this is repaid it has no tax or NI consequences.
Tip. There’s another good reason for paying a salary. Where it exceeds the NI lower earnings limit (£6,396 for 2022/23) is will count towards entitlement to Sarah and her colleagues’ state pension.
Paying a salary that doesn’t exceed your tax-free allowances and NI threshold means your company receives corporation tax relief without any tax or NI cost for you or it. It also counts towards your entitlement to the state pension. Your company doesn’t need to pay the salary; it can preserve its cash by treating the salary as an IOU.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.