Despite our struggles with uncertainty in recent years, one thing that never changes is the need to pay our workforce and shareholders. Shareholder and pay as you earn (“PAYE”) salaries are two primary ways to pay a shareholder of your business. Finding the method for you ultimately comes down to what method best fits your unique situation. This article provides insight into the challenges and problems you could encounter and which method could help combat those scenarios.
Paying shareholders via a PAYE salary is a quick and simple method. The benefit of this method comes in the form of its ease of paying tax on your earnings. Taxpayers receiving PAYE salaries can rely on their income tax being paid on a monthly basis at the same time the business files its monthly employer deduction forms with the IRD. This eliminates the risk of provisional tax compliance issues and simplifies one’s tax position by ensuring up-to-date tax payments to minimise income tax liabilities. Any PAYE salary payments to taxpayers would be net of income tax and can be used without the need to put money aside to pay provisional tax later in the year. Extended advantages of the PAYE method include the allowance for employers to contribute towards Kiwisaver and any monthly student loan repayments.
On the flip side, if you vary your PAYE earnings during the year, you may be required to pay terminal tax at the end of each year if your tax deductions are incorrectly calculated. Similarly, if your company ends up making a taxable loss at the end of the year, it will mean you would have ended up paying more tax for that year given you paid tax on your PAYE salary throughout the year.
An alternative method is for shareholders to pay themselves a shareholder’s salary at the end of each year. Under this method, shareholders would tend to take money out of the business as drawings throughout the year. A shareholder salary would then be calculated at the end of the year, typically in consultation with your trusted accountant, and be offset against these drawings. These transactions will be recorded against your shareholder current account. A shareholder salary would require the shareholder to pay provisional tax three times during the year.
The benefit of this method is that your company would only be recording a shareholder salary up to your company’s taxable profit.
On the flip side, this method could result in you inadvertently taking more money out of the business than what your shareholder salary could cover. If, at the end of the financial year, your shareholder current account becomes overdrawn and you owe the company money, you will either be required to pay fringe benefit tax (“FBT”) on this loan or be charged interest to avoid FBT.
Similarly, shareholder salaries may not be an appropriate option where there are multiple independent or non-associated individuals. PAYE salaries may be used as part of a formal shareholders agreement which could allow shareholders to be remunerated based on their roles and responsibilities.
Why not both?
If both methods have specific issues that make you conflicted about choosing one, it may be time to consider a mixture of the two. From 1 April 2017, a mixture of PAYE salary and shareholder remuneration became an available option for shareholders to utilise. Using this method, a well-planned salary helps shareholders decrease provisional and year-end terminal tax costs while maintaining a possible end-of-year top-up payment determined through operating performance.
It is important to mention that there is no right or wrong way. Many businesses determine their method of payment carefully through their unique circumstances. It is crucial for any established or aspiring business to identify those circumstances and conclude based on what way meets its needs. Structuring an efficient and well-thought shareholder remuneration can be challenging but doing so can provide benefits to both you as a shareholder and the company from a cash flow perspective.
For more information and which strategy might suit you, or if you don’t have a trusted advisor, then reach out to the team at Bellingham Wallace.
Author – Ken Chen