Although it’s easy-peasy to create a limited company, it’s much harder to navigate the taxes associated with becoming a director. As a sole trader, it’s more straightforward and similar to being an employee. Once you’re a company director, you’re both a corporation/employer and an individual/employee. Yes, you get a dual identity. And you pay taxes through both identities.
In this post, I’ll explain the various taxes you pay as a company director and give a worked example, based on a typical setup. This is no substitute for seeking advice from an accountant, though. They can give you specific guidance on your situation. I won’t address taxes that apply only in certain niches, or cover people with income from multiple companies or employers.
Once you’ve deducted your costs from your turnover, that leaves your profit. You’re then taxed at 19% on all your profits. Unlike personal income tax, there’s no tax-free threshold. Even if you make £100 in profit, you need to stump up £19 in corporation tax. You’re right, this is very unfair on new businesses.
You should complete a Corporation Tax return each year. Your tax payment is usually due nine months and one day after the end of your company’s financial year. This is different from personal tax returns, which are due in January.
If you pay a salary to yourself or anyone else and it’s above £8,632, you must pay Employer’s National Insurance (NI) at a rate of 13.8%. There’s an upper limit of £50,000, beyond which no NI is due. Accountants often recommend paying yourself a salary of £8,632 so you avoid NI as both an employer and an employee (see below).
NI payments are made through your monthly payroll system.
Value Added Tax
If you’re VAT registered, you need to charge VAT on sales and then pay it to HMRC every quarter. The good news is that the amount due is reduced by however much VAT you’ve spent on products and services for your business. Assuming you’re managing your cash flow properly and aren’t spending the VAT revenue between quarters, this tax shouldn’t make a dent in your finances.
No doubt you’re already familiar with income tax. As a company director, though, you often don’t pay it – depending on how you pay yourself. As I mentioned earlier, accountants often recommend that company directors pay themselves a salary of just £8,632. This falls below the personal tax allowance of £12,500 and the NI threshold.
Your salary counts as a cost to your business, so it’s not included in the profits on which Corporation Tax is applied.
As an employer, you pay NI only above £8,632 and it’s the same for employees.
So, a salary of £8,632 isn’t liable for either NI or income tax. As a director, you often pay yourself an additional income in dividends, which are taxed differently.
Now, this is where the sums get more complicated. Dividends are taxed at three different rates, depending on where they fall within the income tax bands. The first £2,000 of dividends are tax-free, then they’re taxed as follows:
£12,501 to £50,000
£50,001 to £150,000
Note, these rates are different from the rates applied to salaried income.
To calculate how much dividend tax you pay, follow these steps:
It’s sensible, of course, to use a calculator, but it’s good to understand how it works so you can spot any discrepancies.
Dividend tax is paid through your personal self-assessment tax return, which is due in January.
There’s lots more on dividend tax on the HMRC website.
How do all the taxes work together?
Here’s an example to show you how it works.
Mel runs her own graphic design business. The turnover is £70,000 and her costs are £20,000. She pays herself a salary of £8,632 and dividends of £30,000. Her tax breaks down as follows:
Company profits = £50,000 (remember, her salary is included in the business costs)
Corporation tax = £9,500 (19% of £50,000)
Salary = £8,632, so no income tax or NI due
Dividends = £30,000
Mel still has some of her personal tax allowance left, as her salary was £8,632. The Personal Tax Allowance is £12,500, so another £3,868 of her dividends are also tax-free.
That takes us down to £28,132 that’s taxable.
Then we deduct the £2,000 dividend tax allowance, bringing the taxable figure to £24,132.
As this is within the basic rate tax band, it’s taxed at 7.5%.
- £9,500 in corporation tax
- £1,809.90 in dividend tax
- A total of £11,309.90
As you can see, this is complex! This is why it’s a good idea to hire an accountant. You’re undoubtedly too busy to keep on top of an array of taxes that change each year. Make sure this cost is included in your pricing. Accounting software, such as Xero or Freeagent, should show how much tax your company needs to pay. You can use a dividend calculator to get an idea of your personal dividend tax liability.
Taxes aren’t desperately exciting, but you don’t really want the excitement of a nasty surprise.