You have a new company as a client. It hasn’t started to trade yet, but the directors want to start taking a salary to ensure tax efficiency for the year. Is this permissible and tax deductible for the company?

New client

The amount and type of start-up costs which businesses incur vary widely, as can the time it takes for them to begin trading. Special tax rules exist to allow relief for pre-trading expenditure. The key feature of the rules is that expenditure incurred up to seven years before trade commences qualifies for tax relief; it’s treated as though it were incurred on the first day of trading.

Restrictions

An important condition for a pre-trading expense is that tax relief is only allowed if the cost would be deductible if trade had already started. Usually this won’t cause any trouble, but the condition might be more of a problem for a director’s salary.

Trap. HMRC’s approach to tax relief for salaries is that they must not be disproportionate to the work done for the business. This argument is most commonly used to deny a tax deduction for salaries paid to members of a director’s family as evidenced by the First-tier Tribunal’s decision in A Nicholson v HMRC [2018] TC06293 (see Follow up ). Therefore, if a director’s salary is not justifiable during the pre-trading period, a tax deduction isn’t permitted.

What is proportionate?

A director’s job before the company starts trading might be different in many ways to that after trading has commenced, but that doesn’t make it any less necessary for the business. Only your clients’ directors will know how much time and effort they put in and so how much salary they can justify. You shouldn’t therefore run into problems with HMRC in respect of claiming pre-trading salary unless it’s very high. Aside from justifying the salary the other limiting factor can be tax and NI efficiency.

Dividends are usually the most tax-efficient income. However, they can’t be paid in the pre-trade period because company law only permits them when the company has profits. At the pre- trading stage profits are zero. Therefore, salary is the only option if a director wants or needs cash income in the pre-trading period. But how much?

Bigger picture

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 optimum amount of salary will depend on how much other income the director has already received in the tax year.

Pro advice. Leaving the salary decision until later in the tax year can mean a more accurate picture about other income can be drawn.

You can advise on NI with more certainty. A director’s salary will be free of NI (employers’ and employees’) where it doesn’t exceed the annual lower earnings threshold. This is £8,632 for 2019/20, but is reduced proportionately where the director is appointed part-way through the year. For example, if your client appoints half-way through 2019/20, the NI threshold is reduced to £4,316 (£8,632 x 50%).

If your client’s directors need income in a pre-trade period, rather than take a potentially tax and NI inefficient amount, advise them to limit it to the NI-free threshold and borrow the rest. The loan is NI free if the money is repaid once the company has started trading. This doesn’t have to be immediately, and can be a tax-free or low-tax option.

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