When you leave permanent employment and your Company commences trading you should be aware of the implications this will have in respect of earnings and how you will be taxed under PAYE and your liability to National Insurance Contributions.
On leaving employment your former employer should give you a form P45 as you are entitled to this by law. Your form P45 shows your gross pay to date and the tax you have paid. Assuming that you are on a cumulative code you will have received a proportion of your personal allowances (also known as free pay) due for the period from 6 April to the date you left employment. When your Company commences trading and you have decided what level of salary and start to pay yourself this will impact on your PAYE position.
If you have chosen to pay a salary above the Lower Earnings Limit (LEL) (see Tax Rates and Allowances for current and forthcoming year rates) you will be required to set up a PAYE Scheme with HM Revenue & Customs. We can assist you with the registration which is free of charge to all new clients.
HMRC will provide a PAYE reference number to your Company. As a director of the Company you have a number of PAYE responsibilities including:
- Maintaining PAYE records, reporting under Real Time Information (RTI) and preparing relevant forms throughout the tax year;
- dealing with the deduction of PAYE and NIC from salaries and paying these deductions to HMRC;
- reporting benefits & expenses for directors and employees (Forms P11D and P11D(b) by 6 July after the end of the tax year.
Interest and Penalties may be charged for late filing and late payments.
Tax deducted under PAYE
Under the operation of PAYE the salary you pay yourself as director will be added to the previous pay. The tax due is calculated on this total figure each pay period (weekly or monthly) with credit given for the tax paid in the year to date. You receive the balance of your personal allowances due each week or month for the remainder of the year. The way in which PAYE should work is that by the end of the tax year (5 April) you have paid the correct amount of tax. Any over or under payment of tax arising in the tax year should automatically be adjusted to ensure that you pay the correct tax on your total gross salary for the year.
If you pay yourself less than LEL it is not necessary to set up a PAYE scheme and therefore PAYE will not be operated. It is not possible therefore for an automatic adjustment to be made to the amount of tax due in the remaining months to 5 April. In order to correct the position and claim the full allowances by means of a refund it will be necessary to submit a Self Assessment Tax Return.
National Insurance Contributions (NIC)
Any salary/bonus paid by the company over and above the Earnings Threshold attracts a liability to NIC. Employee’s NIC is deducted from the salary/bonus paid to the director/employee. Employer’s NIC is payable by the Company on the salary/bonus.
The way in which NIC is calculated for directors is different to the calculations for employees. The calculation for directors is based on an annual earnings period rather than the normal pay periods (weekly or monthly) used for employees. There are two methods for actually calculating NIC for directors. The first is the standard method under which the total salary/bonus from the directorship are added together, NIC is calculated on this total amount with credit given for NIC paid to date for that year. The alternative method is to calculate the NIC due on a payment-by-payment basis as for any other employee. When the final payment of a director’s salary/bonus in the tax year is being made the NIC due must be reassessed on an annual (or pro-rata annual) earnings period.
This does not mean that a director will pay any more or any less NIC than an employee.
Own Limited Company to permanent employment
If you decide to return to permanent employment (and your limited company ceases trading) if PAYE has been operated on your salary you will be provided with a form P45 showing details of your gross pay, tax deducted and the code operated for the year to date. When you provide this P45 to your new employer the PAYE system will continue as described above and again, by 5 April the system should have adjusted to ensure the correct tax is deducted for the year.
Where it has not been necessary to set up a PAYE scheme no P45 will be provided to you. When you commence with your new employer and advise them you do not have a form P45 you will be required to provide certain information to your new employer. You will have to provide a declaration regarding your employment sitution and this information will enable your new employer to ascertain what code number is to be operated. It is likely that you will be put on an Emergency code on a week 1/month 1 basis until HMRC are able to advise the employer of the correct code to operate. If this is not established before the end of the tax year (5 April) then it is possible you may have overpaid/underpaid tax. In order to claim the repayment due or if you have an underpayment you will have to submit either a repayment claim or a Self Assessment Tax Return.
If an employer does not have the information to establish the correct code number before the first pay date they will have to use the ‘default’ code number. The default code OT will apply which provides no personal allowances and applies all the tax bands – basic rate, higher rate (40%) and the additional rate (45%), where appropriate.