Avoiding the “salary trap”

Many directors withdraw funds from their limited company using a low salary / dividend combination.  The benefit being a preferential tax position and no National Insurance to pay on dividends.  However be aware that it’s becoming more common for HMRC to argue that where a director uses the company account to pay a personal bill, it counts as salary.

How can you disprove this argument and save money in the process?

Here’s an example taken from our Accounting & Taxation periodical which you may find interesting:

Director’s loan

One of our subscribers, the only director and shareholder of a company, came under fire from HMRC because he used his company’s bank account to make payments to the building firm which was adding an extension to his home. The maximum he borrowed at one time was £12,000 and all the money was repaid during the same tax year and just two months after the company’s accounting year ended. Our subscriber’s accountant reported the arrangement as a loan although there was no formal paperwork to prove it.

HMRC’s salary trap

The tax inspector reviewing the company’s accounts took a different view to the accountant. He suggested that the payments were additional salary on which the company should have accounted for PAYE tax plus employees’ and employers’ NI. If the inspector was right, the extra tax and NI due would be significant.


The company’s accounts were prepared showing that at the year end the director owed £12,000 to his company. The accountant’s view was that the £12,000 was an interest-free loan which gave rise to a taxable benefit in kind (BiK). The accountant worked out that the tax payable by the director on this would amount to less than £100. This BiK was reported on Form P11D and our subscriber declared it on his tax return.

Tax enquiry

Based on what he saw in the company’s accounts and Form P11D, the tax inspector started an enquiry and issued a demand for PAYE tax and NI on the £12,000 drawn by the director. This ran to several thousand pounds. Naturally, our subscriber appealed, but the inspector dug his heels in and pressed for full payment.

HMRC’s view

According to the inspector, his view is backed up by legislation which says any payment made by a company to or on behalf of a director that can be construed as “money or money’s worth” counts as pay and PAYE must be applied. We’ve seen this argument before and while it’s difficult to dispute the logic in practice, HMRC’s official guidance takes a partially different view.

Tip 1.

If an inspector suggests that payment of a personal bill by your company is subject to PAYE tax, firstly point them to HMRC’s guide for employers, Booklet CWG2 . This says that such an arrangement is a BiK and so not subject to PAYE tax. But the bad news is that it counts as salary for NI purposes meaning both employers’ and employees’ contributions are due.

Tip 2.

You can avoid NI by arranging for personal bills to be invoiced in your company’s name instead of yours. This dodges the “money’s worth” trap because when your company pays the bill it’s meeting its own debt not yours. What’s more, if you reimburse your company for the bills within three months after the tax year in which it paid them, you won’t be taxed on a BiK. In effect you’ll have had tax and NI-free use of company money.

CREDIT: Tax Essentials for Advisors

At a4c our view is to avoid the salary trap altogether and not pay personal expenses from your business account.  Keep your financial affairs and those of the business entity truly separate.

If you need additional funds for a building project at home or other unexpected costs then investigate whether declaring a dividend would be a more suitable option.

To talk through your choices don’t hesitate to give the lovely team at a4c a call on

01737 652 852

or email info@a4cgroup.co.uk.