New companies - how soon can a director be paid?
You’ve formed a company and are in the process of getting it up and running. As it hasn’t generated any income yet can it pay you a salary, and if it does will it be entitled to tax relief for it?
New company
When a company is formed it’s normal for there to be some time - weeks or even months - before it starts trading. Because general tax rules only allow deductions from trading income, special rules exist to allow such expenses to be deducted from income once trading has begun. Expenditure incurred up to seven years before trade commences can qualify for tax relief in this way, subject to conditions.
Conditions for tax deductions
To be tax deductible as a pre-trading expense it must meet the conditions for tax deduction that apply when a company is trading. Usually this won’t cause any trouble, but a director’s salary is trickier.
Tax relief for salaries must not be disproportionate to the work done for the business. HMRC uses this approach to refuse a tax deduction for salaries paid to members of a director’s family where it suspects they are being paid to avoid tax and NI costs that would otherwise fall on the director. Therefore, to qualify for a tax deduction a director’s salary must be justified by the work they do in the pre-trading period.
How much?
A director’s activity in their company before it starts trading will typically be different to that after it has begun, e.g. involve work finding a premises, setting up contracts, etc. Only the directors will know how much time and effort this takes and so how much salary they can justify. HMRC is unlikely to challenge the level of salary unless it looks excessive. However, the director should consider tax and NI efficiency of the salary.
Dividends are usually the most tax-efficient income. But they can’t be paid in the pre-trade period because company law only permits dividends to be paid out of profits, which pre-trading will be zero. Therefore, salary is the only options if a director wants or needs cash income in the pre-trading period .
Tax and NI efficiency
The same principles of tax and NI efficiency apply for the pre-trading period as they do when the business is up and running. The most efficient amount depends on how much other income the director has already received in the tax year. NI efficiency is more straightforward. A director’s salary will be free of NI (employers’ and employees’) where it doesn’t exceed the annual secondary earnings threshold (£9,100 for 2023/24), but is reduced proportionately for a person who only becomes a director during the year.
Limit a director’s salary in the pre-trading period to the NI-free threshold. Top up the director’s income if needed with an interest-free loan. This can be tax and NI free if the money is repaid once the company has started trading. Such a loan can be very tax and NI efficient.
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