When considering the tricky matter of remuneration planning, there are two things to consider; the amount of remuneration, and what form it takes.
How Much?
The amount employees receive should be commensurate with their employment duties for the employer to claim tax relief on the salary. The payments must have been incurred ‘wholly and exclusively’ for the purposes of the trade, profession or vocation (per ITTOIA 2005, s 34 and CTA 2009, s 54). If the level of salary is higher than the job warrants, HMRC could deem the excess to be an effective gift, a non-business payment, and thus not deductible for the business. This may be more likely to happen in family businesses where family members are employed, and the notion that these bounteous payments might be made is possible.
An employee is subject to income tax and Class 1 National Insurance contributions (NICs) on salaries or bonuses under PAYE, which their employers are obliged to maintain and pass the tax onto HM Revenue and Customs (HMRC). Employers in Scotland need to bear in mind that the Scottish tax bands for employment income (whereas NICs is based upon UK rates) for their Scottish employees. Directors receiving a salary are treated in the same way (although NICs is assessed on an annual basis).
How to be Paid?
Salary or bonuses are what employees and directors usually receive – but other possibilities might need to be considered:
- Benefits-in-kind – whilst subject to the same rates of income tax, employees do not pay NICs on these benefits; employers only pay Class 1A NICs. Some benefits are tax-free (e.g., a phone for private use, extra holidays, extra employer pension contributions, car parking at or near the workplace, workplacebased childcare, Cycle to Work schemes, and cheap loans under £10,000). Benefits provided under a salary sacrifice scheme can save the employee income tax, but there are still NICs savings to consider.
- Shares – employees might receive shares in their employer’s limited company. Under the employment-related securities rules, those employees will be taxed on the value of the shares, less any amounts paid. For shares which are not ‘readily convertible assets’, there will be no NICs chargeable either. By giving employees a stake in the business, other than the NICs treatment, there is no immediate tax saving. However, once in possession of shares, the employees can receive dividend income going forward, which is subject to lower tax rates and exempt from NICs. In addition, it gives some incentive – employees will feel more than being simply hired help. If they hold sufficient shares and voting rights, then if an employee does decide to leave and sell their shares, they may well qualify for the lower 10% capital gains tax (CGT) rate via business assets disposal relief (BADR).
- Share options – instead of shares themselves, employees might be given the option to purchase them at a discount; these options may come with strings attached as a further incentive. Exercising unapproved share options will attract income tax in the same way as buying shares, depending on how much they pay for the shares in relation to their value. HMRC-approved share option schemes (e.g., Save As You Earn (SAYE), Company Share Option Plans, and Enterprise Management Incentive (EMI) schemes) provide for greater incentives with tax reliefs. For example, SAYE and EMI schemes allow employees to purchase shares at a fixed price at a future date; if that price is below the market value at the time of exercise, there is no income tax charge on the difference. Any future sale would allow that growth to be taxed under CGT rather than income tax; the BADR regime is also a little more favourable towards EMI shares. Share options often give more flexibility and further incentive than simply providing shares outright – especially if there is some tax advantage.
Practical Tip
Whilst shares offer greater long-term tax advantages to employees than salaries, they are potentially more complicated and will give the employee a stake in the businesses; a useful incentive, maybe; but it may be an unwelcome intrusion into smaller family-run companies.
