It is important to understand the tax laws around how a small business owner can pay themselves.
There are three primary options for small business owners of a close company to pay themselves.
1. A regular PAYE based salary that equates in essence to a fair market value of the work you do for the company.
2. Shareholder Salary allocated from end of year profit. This is not a PAYE based salary. The tax obligations fall to the shareholder to account for in their end of year tax return. If the amount of tax is over $2500 the income is subject to provisional tax calculations and payments.
3. Dividends. Profit is retrained in the business. At the end of year it is distributed as a dividend to selected shareholders. There are more complex tax issues resulting from this depending on your level of earnings and top dollar tax rate.
Changes to tax law effective from the 1st April 2017 for shareholder-employees simplify and benefit small business owners.
Prior to 1st April 2017 it was not possible to pay yourself a PAYE paid salary and end of year profit allocated shareholder salary without PAYE. You had to choose one option or the other.
Since the 1st of April2017 tax reforms this has been simplified and benefits small business owners of close companies.
The situation now allows close company shareholder-employees to:
Be paid a base salary (as long as it is reasonable and reflective of market rates for the work done). This regular salary payment is subject to PAYE and other employee related expenses and benefits. Be mindful that IRD states “Deduct PAYE from: regular salaries paid to shareholder-employees for pay periods of one month or less.” (Note it is important that you have an employment contract in place for you as an employee signed by you as the company owner as well.)
Shareholder end of year profit allocation top-up salary. The business can now pay you the difference between your base salary and remaining end of year profit as a shareholder-employee payment. IRD advises “Don't deduct PAYE from irregular salary payments made to a shareholder-employee.”
Points to consider when electing how to pay your-self as a shareholder-employee.
REGULAR PAYE SALARY
Benefits of a regular PAYE salary.
Benefits of a regular PAYE salary.
Reduces provisional tax compliance issues.
Assists with ACC claims in the event of an accident.
Can add in Kiwi Saver and other employee benefits from PAYE salary.
Simplifying your tax position, ensuring you are current with income tax payments via the PAYE system.
Provides regular income and can be considered as more favorable by lending institutions.
Disadvantages of regular PAYE Salary
Salary and PAYE can’t be reduced in the event of an unexpected company downturns resulting in diminished profit. The tax must still be paid on the salary and company losses as a result of overpaid shareholder salary need to be carried forward to future years to be used.
Once you have chosen the PAYE salary form of shareholder payment, this must be continued in future years. You cant switch between the two systems exclusively. You can however reduce your salary in the event of diminished profitability.
Your salary must be at a fair market value or it can be perceived as tax avoidance by the IRD.
IRREGULAR NON-PAYE SHAREHOLDER-EMPLOYEE PAYMENTS
Benefits of Irregular non-PAYE shareholder-employee payments
Leaves cash in the business until needed.
Easier to account for unexpected business performance.
Reduces the need for retained earnings and dividend payments.
Disadvantages of Irregular non-PAYE shareholder-employee payments.
Provisional tax compliance issues, important to accurately estimate your expected next year income and pay the appropriate provisional tax on this estimate. Under payment of provisional tax could result in the IRD charging you use of money interest (UOMI).
Ensuring that you have saved sufficient to cover possibly substantial provisional tax payments throughout the year.
It is possible to be disadvantaged in applying for loans when irregular shareholder-employee income is your only source of income. Some banks will accept this, others not as easily.
Shareholder-employee payments taken during the year are a reduction in the shareholder current account. If this account falls into negative then tax law requires that the company charge Use of Money Interest (IOMI) on the negative balance at the current prevailing IRD rate or this is subject to fringe benefit tax.
Important to remember to account for ACC levees on this money. According to the IRD. “ACC will invoice close company employers for earners' levy on shareholder-employee remuneration that doesn't have PAYE deducted. The levy will be based on the shareholder-employee remuneration declared in the company's IR4 income tax return.”
With great care, a well planned and considered balance between PAYE shareholder-employee salary and Non-PAYE shareholder-employee salary should result in minimal Provisional Tax, terminal tax payments, flexibility of payment of profit based income and the benefits of being a PAYE salary employee with ACC and Kiwi-Saver benefits, regular personal income and peace of mind. Seek the advise of an expert to assist you in creating the best possible outcome for payments as a small business owner.
This material has been prepared for information purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your normal source of expert advice before acting on anything.
Notes for writing up the above
Shareholder-employees in close
Companies
Deduct PAYE from:
Regular salaries paid to shareholder-employees for pay periods of one month or less
Other payments made to shareholder-employees we consider to be liable for PAYE.
Don't deduct PAYE from irregular salary payments made to a shareholder-employee.
Include in the IR4 company tax return all shareholder-employee salaries where PAYE has not been deducted.
Reference IR Employers Guide IR335 July 2019
ACC will invoice close company employers for earners' levy on shareholder-employee remuneration that doesn't have PAYE deducted.
The levy will be based on the shareholder-employee remuneration declared in the company's IR4 income tax return.
Closely Held Companies
Shareholder-employees currently have no option to split their tax obligations between PAYE and provisional tax, it’s one or the other. The proposal in this bill allows some flexibility by giving shareholder-employees the option to return PAYE on their base salary amount while the variable amount relating to business performance (paid out pre-tax) will be subject to provisional tax instead. The main purpose of this is to reduce compliance costs and take more guess work out of provisional tax calculations.
BDO
Prior to 1 April 2017, a shareholder employee was not able to draw a PAYE salary, and allocate further profit to the shareholder salary without PAYE being deducted. This led to the difficulty in situations where the shareholder would draw the profit out of the business in the form of cash drawings during the year, and sometimes end up with an overdrawn shareholders current account at year end, along with related adverse tax consequences.
Since 1 April 2017, shareholder employees are permitted to take both a PAYE salary during the year and a “lump sum top up” at year end. This is a more sensible approach that directly deals with the problem of an overdrawn shareholders current account.
It is permitted that annual shareholder salaries are credited to a shareholders current account at the first day of the year, thus minimising mandatory interest charges, or worse, deemed dividends, in relation to overdrawn shareholders current accounts.
As a shareholder employee taking a PAYE salary during the year, your tax is paid monthly relative to the amount of the salary received. Any year end top-up will be subject to provisional tax. However, the provisional tax can be minimised if the tax is efficiently covered by the PAYE on the salary during the year. Also, significant provisional tax payments could be made throughout the year, in two or three instalments, and, if the annual taxable income is reasonably estimated, this would leave a small terminal tax to be paid at year end, when the final tax is settled.
As a shareholder you will still have to carefully estimate your annual income for provisional tax purposes. If you underpay the provisional tax, IRD may charge you use of money interest (UOMI), as per current Inland Revenue requirements.
A shareholder would however be permitted to reduce the salary as long as it is not tax avoidance, which would transpire if the remuneration provided to the shareholder employee is deemed to be less than market rate remuneration for the services rendered.
If the company makes a loss as a result of your PAYE salary, you will not be able to reduce your personal taxable income by the amount of the loss. The loss will be trapped in the company until it can be set off against profits derived in future years.
The only exception would be if the company happens to be a Look Through Company (LTC) and, from 1 April 2019, if the loss is not derived from the business of residential rentals.
This material has been prepared for information purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your normal source of expert advice before acting on anything.
