Lee Sharpe looks at the tax efficiency of salary and benefits-in-kind, in particular where there are multiple employments.
Benefits-in-kind describe remuneration in the form of goods or services rather than money. Typical benefits-in-kind include:
- Company car provided for private (non-business) use; likewise fuel;
- Health insurance;
- Health or golf club membership;
- Mobile telephone for work and for non-business use;
- Provision of canteen, drinks or snacks in the workplace.
Tax and NICs
While a handful of benefits-in-kind are tax-free, the vast majority are taxable. In other words, the employee pays tax on the ‘cash equivalent’ of the benefit, and the employer pays Class 1A National Insurance contributions (NICs).
If HMRC is aware of the benefit-in-kind, it will adjust the employee’s tax code to collect the appropriate amount of extra tax over the tax year; the employer pays the Class 1A NICs due (at 13.8% - just like ordinary employer’s NICs on salary) when it makes its annual return of taxable benefits provided on forms P11D/P11D(b) in early July following the relevant tax year. The employer can also ‘payroll’ the benefit, meaning the employer works out what additional tax the employee should pay and deducts it accordingly as part of the usual wages/salary run – effectively taking over the burden of adjusting the employee’s tax code from HMRC.
Note that the employee does not generally pay employees’ NICs on taxable benefits, unlike with ordinary cash wages or salary. This can mean a potentially quite significant saving when compared to simple cash.
It is not uncommon for a director/shareholder to be employed by several separate companies that he or she runs, or to be employed by several companies in a group.
Most readers will be well aware that a single employer can pay up to the primary threshold and the director (or indeed any employee) without having to pay employees’ NICs; in 2019/20, the primary threshold is £166 per week (£8,632 per year). As this is also the employer’s secondary threshold, it means that a salary of £700 a month will attract no employees’ or employers’ NICs. However, a salary of £720 a month would, as that equates to £8,640 a year; note that NICs on directors’ pay is calculated on a special cumulative annualised basis, so there would be no real advantage in paying £700 a month for 11 months and then paying (say) £5,000 in Month 12.
It would theoretically be possible for a director shareholder to create several companies, arrange for them each to pay up to that £8,632 limit, and escape NICs for himself and for the company. This would not save any tax because that is worked out cumulatively for the year from all sources, but NICs are typically calculated independently by each employer.
There is, however, a basic anti-avoidance regime, which requires earnings for NICs purposes to be aggregated across multiple employments, where the employers are carrying on ‘business in association with each other’. HMRC’s interpretation of the meaning of that phrase is found in its National Insurance manual at NIM10010, but it is broadly similar to the rules for associated companies that persisted until the harmonisation of corporation tax rates for small and larger companies from 1 April 2015, meaning that the employers must share a common purpose, or interdependence, substantiated by the sharing of facilities, office space, customers and clients, or personnel (and that last one is not automatically ticked merely by sharing a common director!).
Broadly, the requirement to aggregate earnings for NICs purposes should combat only scenarios where there has been a deliberate attempt to sub-divide employers, and independent companies should not be caught.
Example: One individual, two companies
Barbie is a hairstylist. Depending on the client, she uses different products but some brands must be provided exclusively, or she would lose distribution rights, so she runs two separate companies as a commercial necessity, even though they both provide hairstyling services, and use common facilities.
In this example, although the business has been split up for purely commercial reasons, it is essentially one business and, if each company paid a separate salary, it would seem appropriate for them to aggregate Barbie’s earnings for NICs purposes.
Ken is a surfing instructor and party organiser. He works from home and uses one vehicle for both activities but, even though he also uses the same home office to run both businesses, they are commercially independent of each other. On that basis, the earnings from one company would not need to be aggregated with the other.
Solution for Barbie?
If we suppose that Barbie’s companies can each afford modest remuneration of around £10,000, it might be useful for each company to pay a salary of £8,400 a year. But if earnings need to be aggregated, the total would exceed the thresholds and there would be a NICs cost in doing so.
A better alternative might be for one company to pay the cash salary as usual, and for the other to pay a package of benefits-in-kind – it would still cost employers’ NICs, but Barbie would avoid employees’ NICs (usually 12% for a basic rate taxpayer) on the benefits.
This could include:
- Private healthcare;
- Club membership;
- Company car (although the provision of fuel benefit is almost always cost-ineffective).
There are even tax-free benefits-in-kind, typically:
- Employer pension contribution (although there are limits, and competent financial advice must always be sought);
- Mobile telephone provided for business use (although any amount of private use is ignored, so long as there was a business purpose to the provision);
- Canteen meals (so long as made available basically to all employees);
- Certain childcare provision (noting that childcare vouchers were closed to new entrants in October 2018, but ‘in-house’ provision may still work).
Arranged correctly, these are free of tax and NICs for the employee and the employer, but still tax-deductible for the employer against business profits
Better than dividends?
Generally, dividends are more tax-efficient than the provision of taxable benefits; but note:
- In the above example, Barbie may still have unutilised tax-free personal allowance, in which case the fact that the company can get tax relief for the provision of benefits-in-kind (but not for dividends) makes benefits more tax-efficient;
- Dividends should normally be paid in proportion to everyone’s shareholding, which can become problematic (but not insoluble) if there are several shareholdings;
- Dividends can be paid only out of profits accumulated to date, so cannot always pay a dividend.
Potential pitfalls for benefits-in-kind
- Just as with practically all expenses, the cost of the benefit must have been incurred wholly and exclusively for business purposes in order to be tax-deductible for the employer/company. HMRC will not normally challenge the benefits package for a ‘significant’ director shareholder but a £50,000 pension contribution for a nephew who does three hours clerical work a week may be more difficult.
- Where the benefit-in-kind is offered as an alternative to a cash package, it will be considered a ‘salary sacrifice arrangement’. Since April 2017, HMRC has applied a punitive regime which broadly provides for such arrangements to be taxed either as the benefit or as the salary sacrificed – unsurprisingly, whichever results in the greater tax yield.
- The employer must contract directly with whoever provides the service or benefit (e.g. the mobile phone operator or life insurance company); otherwise, HMRC may argue that the employer is merely settling the employee’s personal bill – and this is basically taxable as if it were cash salary.
Not cut and (blow) dried
‘Benefits-in-kind’ can offer a relatively tax/NICs-efficient component of someone’s remuneration package in the right circumstances – in particular, where salary would potentially cost more NICs but in some cases, even when compared to a dividend alternative.
However, benefits have their own traps for the unwary taxpayer, and readers should check with their advisers before updating their remuneration policies.