Taxation and PAYE for Director-Owners (2025/26)

Introduction

Most new director‑owners do not think about PAYE when they form a company. For business startups, the immediate focus is usually on company formation, opening a bank account and starting to trade, rather than on payroll registration.

This guide sits within the broader tax considerations for small UK companies and start-ups:
UK Taxation for Small Companies & Start-ups (2025/26).

Once trading begins, however, owners must make decisions about how they reward themselves and take profits from the business. If the company employs staff, they must also understand when PAYE registration becomes mandatory and how payroll must be operated. In addition, directors need to understand how PAYE applies to them personally, as the rules for directors differ in important respects from those for standard employees.

In addition to PAYE, directors should understand the tax treatment of dividends, taxable benefits and pension funding at both company and personal level. Only then can informed decisions be made about how profits are extracted and how overall tax exposure is managed within the rules.

This article looks at ten aspects of UK tax and PAYE law that director-owners will have to consider after incorporation.

Key Definitions

Tax year 2025/26: The UK tax year running from 6 April 2025 to 5 April 2026, during which all thresholds and figures in this guide apply.

Taxable earnings: Salary or any payment treated as earnings under ITEPA 2003.

Taxable benefits: Benefits or reimbursements that must be reported through payrolling or P11D.

Pay period: The interval used to calculate pay for standard employees (weekly, monthly or four‑weekly).

Employment Allowance (EA): Relief that reduces employer NI by up to £10,500 where eligibility criteria are met.

Secondary Threshold (ST): The earnings level at which employer National Insurance becomes payable. For the 2025/26 tax year, the Secondary Threshold is £96 per week, equivalent to £417 per month or £5,000 per year.

Primary Threshold (PT): The earnings level at which employee National Insurance becomes payable. For the 2025/26 tax year, the Primary Threshold is £242 per week, equivalent to £1,048 per month or £12,570 per year.

pper Earnings Limit (UEL): The level of earnings above which employee National Insurance is charged at the additional rate rather than the main rate. For the 2025/26 tax year, the Upper Earnings Limit is £967 per week, equivalent to £4,189 per month or £50,270 per year.

NIC (National Insurance Contributions): including both employee National Insurance and Employer’s contributions.

Relevant earnings: The earnings of an employee or director that count for the purposes of calculating the maximum level of personal pension contributions eligible for tax relief. Relevant earnings generally include salary and other taxable employment income, but exclude dividends and most other forms of unearned income.

For the salary vs dividend and Employment Allowance strategy overview, see:
UK Taxation for Small Companies & Start-ups (2025/26).

PAYE Registration

A company must operate PAYE when any of the following apply.

• The company pays an employee (including a director-owner) £5,000 or more per year

  For 2025/26, HMRC’s PAYE registration trigger includes paying an employee £96 or more a week (equivalent to £417 a month or £5,000 a year). If you pay any one employee at or above this level in the tax year, the company must operate PAYE.

• Any taxable benefits or non-allowable expense reimbursements are provided

  If the company provides any taxable benefit, or reimburses an expense that is not tax-deductible under HMRC rules, it must run PAYE. Payrolling benefits or filing P11Ds requires an active PAYE scheme, and taxable reimbursements are treated as earnings for PAYE purposes.

• The director or employee already has another job or receives a pension

  A company must operate PAYE on any salary paid to a director or employee who already has another employment or pension income. PAYE is required so HMRC can apply the correct tax code and collect the correct tax across all employments.

  A company that pays only dividends, and provides no salary and no taxable benefits, does not need a PAYE scheme until one of the above conditions is met.

The Employment Allowance (EA) — £10,500 for 2025/26

The Employment Allowance reduces employer National Insurance by up to £10,500. It applies only when a company:

• has at least two people on the payroll ( one of which is a director) earning more than £5,000; and
• has employer NI to offset.

A company with only one director on the payroll and no other employees does not qualify for the Employment Allowance.

Directors’ National Insurance Rules (Annual Earnings Basis)

Directors are subject to National Insurance Contributions (NIC) rules that differ from standard employees. NIC for directors is calculated on an annual earnings basis, not per pay period.

For the full technical appendix with NIC calculations and band slicing, see:
Supporting Appendix – Full Technical Workings (2025/26).

This means:

• NIC is worked out on total earnings for the tax year, rather than by reference to weekly or monthly thresholds;
• irregular or one-off payments are permitted; and
• salary can be paid later in the tax year without breaching NIC rules.

Because directors are assessed annually rather than per pay period, these rules explain why irregular or year-end payments are allowed and how NIC applies to them. For example, a director-owner who draws £90 per week for most of the year and then takes a final payment to bring total earnings to £12,000 will not pay NIC earlier in the year, but NIC will be calculated in the final pay run as if earnings had been spread evenly across the tax year. This is particularly relevant for director-owners who may take variable remuneration in the early stages of trading.

Accounting Treatment of Directors’ Remuneration (Including the 9-Month Rule)

Directors sometimes postpone withdrawing cash in the early stages of a company’s trading. For accounting and tax purposes, remuneration that has been earned but not yet paid can be treated in one of two ways. The method chosen determines both the timing of corporation tax relief and whether the director-owner’s personal allowance and tax bands are used in the correct tax year.

For salary, dividends and pensions — and how to structure year-end extraction — see:
UK Taxation for Small Companies & Start-ups (2025/26).

• Accruals method

  Unpaid remuneration may be accrued in the company’s accounts. It is recognised as an expense, but corporation tax relief is only available if the amount is actually paid within nine months of the company’s accounting year-end. If payment is delayed beyond this point, the corporation tax deduction is deferred until the year in which the remuneration is processed and the payment made.

• PAYE processing credited to a director’s loan account

  Alternatively, remuneration can be processed through PAYE within the tax year and the net amount credited to the director’s loan account. For tax purposes, this counts as paid even though no cash is withdrawn. This ensures the director-owner’s personal allowance and tax bands are used in that tax year, and the company receives corporation tax relief in the same period. The company will, however, have to settle any PAYE liability at the time the salary is processed.

Employing a Spouse or Civil Partner — PAYE and Corporation Tax Considerations

Director-owners can place a spouse or civil partner on the company’s payroll. Two distinct issues must then be addressed: PAYE operation and whether the salary qualifies as an allowable business expense.

• PAYE eligibility

  A spouse or civil partner can always be added to the payroll. Paying them through PAYE is not an issue in itself. The key requirement is simply that PAYE is operated correctly on any salary processed.

• Whether the salary is an allowable business expense

  Once a spouse or civil partner is on the payroll, the key question is whether the salary qualifies as an allowable deduction for corporation tax. HMRC applies the “wholly and exclusively for the purposes of the trade” test. To satisfy this test:

  • the spouse or civil partner must carry out genuine, identifiable work for the company; and
  • the remuneration must be commercially justifiable for the duties performed.

If these conditions are not met, HMRC may reclassify the payment. This can occur in two ways:

• the payment may be treated as a distribution rather than a salary expense; or
• it may be treated as a director’s own remuneration, meaning PAYE and NIC should have been operated on the director instead.

Reclassification can result in additional PAYE, NIC, interest and penalties. Ensuring that duties are genuine and pay is commercially reasonable avoids this risk.

What Is Deductible for Corporation Tax?

Directors should understand the distinction between remuneration and expenses that qualify as tax-deductible business costs and payments that HMRC may treat as an appropriation of profits. Only amounts that are incurred wholly and exclusively for the purposes of the trade reduce the company’s taxable profits.

Deductible (and reducing tax payable by the company)

These items normally qualify for a corporation tax deduction because they are incurred wholly and exclusively for the company’s trade:

• remuneration paid for genuine work performed;
• employer NI arising on allowable remuneration;
• employer pension contributions that meet the wholly and exclusively test; and
• reimbursed business expenses that would have been deductible if incurred directly by the company.

Not deductible (no impact on the company’s tax liability)

These items do not reduce the company’s taxable profits because they represent a return of profits to the director-owner or are not incurred wholly and exclusively for the trade:

• dividends;
• personal drawings;
• payments to family members where duties or pay are not commercially justifiable; and
• expenses with a personal element, such as private use of vehicles, home broadband without business apportionment, non-uniform clothing, or mixed-use mobile phone costs where the personal element cannot be identified.

Understanding this distinction helps director-owners minimise overall taxes by ensuring that deductible costs are not mistaken for profit distributions.

Pensions — Three Ways to Fund a Director’s Pension

A director’s pension can be funded in three main ways. Each is treated differently for tax, National Insurance and corporation tax purposes.

• Employer pension contributions

  These are paid directly by the company into a pension scheme. They:

  • are deductible for corporation tax if commercially justified;
  • do not depend on the level of the director-owner’s salary;
  • are not subject to income tax or NI when paid; and
  • count toward the pension annual allowance (£60,000).

• Salary sacrifice

  Salary sacrifice is a contractual arrangement under which the director-owner agrees to give up part of their salary and the company pays the equivalent amount into a pension.

  • the sacrifice must be agreed before the salary is earned;
  • it must be a genuine contractual change, not an after-the-fact adjustment; and
  • it removes the sacrificed amount from taxable salary, reducing income tax and both employee and employer National Insurance on that amount.

• Personal pension contributions (paid after tax)

  These are paid personally by the director-owner from net income. They:

  • receive 20% tax relief at the UK basic rate at source, even for Scottish taxpayers who have a basic rate of 19% tax;
  • allow higher-rate or additional-rate relief to be claimed through Self Assessment; and
  • are limited to the lower of £60,000 or 100% of relevant UK earnings.

Personal contributions do not create corporation tax relief and do not provide NI savings.

For worked calculations covering salary, dividends, pension funding and marginal relief, see:
Supporting Appendix – Full Technical Workings (2025/26).

Using the annual allowance and carry forward

Director-owners may be able to contribute more than £60,000 in a tax year if they have unused annual allowance from the previous three tax years. This is known as carry forward. The maximum available in 2025/26 is up to £240,000, subject to the rules for each contribution type.

Salary, Dividends and Employer Pension Contributions — Tax Rates

Once profits exist, director-owners need to understand how different tax rates apply depending on how profits are taken from or retained by the company. Salary, dividends and employer pension contributions are each taxed under different rules, which affects both the tax paid and the cash retained.

Salary — income tax and National Insurance

Salary paid to a director-owner is taxed as employment income. It is subject to income tax at the director-owner’s marginal rate and may also attract employee and employer National Insurance.

For 2025/26, income tax on salary applies at:

• 20% on taxable income up to £50,270;
• 40% on taxable income between £50,271 and £125,140; and
• 45% on taxable income above £125,140.

Where total income exceeds £100,000, the personal allowance is withdrawn at a rate of £1 for every £2 of income. This creates an effective marginal income tax rate of up to 60% on income falling within that band. Salary falling in this range can therefore be particularly expensive from a personal tax perspective.

Salary may also attract employee National Insurance and, unless covered by the Employment Allowance, employer National Insurance.

For the 2025/26 tax year:

• Employee National Insurance is charged at 8% on earnings between the Primary Threshold and the Upper Earnings Limit, and 2% on earnings above that level;

• Employer National Insurance is charged at 15% on earnings above the Secondary Threshold, subject to any available Employment Allowance.

Dividends — lower headline rates, but paid from post-tax profits

Dividends are taxed on the shareholder rather than through PAYE and do not attract National Insurance. For this reason, they are often viewed as attractive compared with salary.

Dividend tax rates for 2025/26 are:

• 8.75% within the basic rate band;
• 33.75% within the higher rate band; and
• 39.35% within the additional rate band.

However, dividends can only be paid out of profits after corporation tax and do not reduce the company’s taxable profits. Dividend income also counts towards total income for personal tax purposes and therefore contributes to the £100,000 threshold at which the personal allowance is withdrawn.

As a result, while dividends may carry lower personal tax rates than salary, they can still increase the overall tax burden once corporation tax and personal tax are considered together.

Corporation tax rates and marginal relief

For the 2025/26 tax year, corporation tax applies as follows:

• 19% on profits up to £50,000;
• Marginal relief on profits between £50,001 and £250,000, giving an effective marginal rate of up to 26.5%; and
• 25% on profits above £250,000.

Payments that qualify as deductible business expenses, such as salary and employer pension contributions, reduce profits that might otherwise be taxed at these rates. Dividends do not.

Employer pension contributions — tax relief without immediate income tax

Employer pension contributions are not taxed as income when paid and do not attract National Insurance. Where they meet the wholly and exclusively test, they reduce the company’s taxable profits and therefore attract corporation tax relief at the applicable rate, including relief at the effective marginal rate of up to 26.5%.

Unlike salary or dividends, employer pension contributions do not increase the director-owner’s taxable income in the year of payment. The benefit is deferred until pension benefits are later drawn.

Why tax rates matter for director-owners

These tax rates explain why different ways of taking profits lead to different cash outcomes. Salary, dividends and employer pension contributions each combine income tax, National Insurance and corporation tax in different ways, affecting how much cash remains available to the company and the director-owner.

PAYE for Non-Resident Directors

Companies frequently have director-owners who are resident outside the UK. Non-residence does not remove PAYE obligations where remuneration relates to duties of a UK company.

UK duties principle

Under UK tax law, a non-resident director-owner is chargeable to UK income tax on earnings attributable to UK duties. For directors, UK duties are interpreted broadly and include duties performed for a UK company, even where they are carried out while the director is physically outside the UK.

Examples of UK duties commonly include:

• participation in board meetings of a UK company;
• strategic decision-making for the UK business;
• approving accounts, filings or corporate actions; and
• managing UK operations or UK staff remotely.

Where any part of a director’s role relates to the UK company, it is common for at least a proportion of their duties to be treated as UK duties.

PAYE obligation

The company must operate PAYE on the portion of remuneration that relates to UK duties. This applies regardless of:

• where the director is resident;
• where the director performs the duties; or
• where the salary is paid.

PAYE must be applied before any relief under a double taxation agreement is considered. Treaty relief, where available, is normally claimed later through Self Assessment rather than by disapplying PAYE at source.

Apportionment of remuneration

Where a director-owner performs both UK and non-UK duties, remuneration should be apportioned on a reasonable basis. This typically involves allocating salary by reference to:

• time spent on UK duties compared with overseas duties; and
• the nature and significance of the duties performed.

Accurate records of board meetings, management activities and time spent are essential to support any apportionment.

Consequences of non-compliance

If PAYE is not operated correctly on UK duties:

• HMRC may recover unpaid income tax and National Insurance from the company;
• interest and penalties may apply; and
• relief under a double taxation agreement may not prevent PAYE liabilities arising at company level.

For this reason, non-resident status should never be assumed to remove PAYE obligations for director-owners of UK companies.

Alphabet Shares — Basic Awareness for Director-Owners

Alphabet shares are used in some owner-managed companies to allow different dividends to be paid to different shareholders. In practice, this can mean that profits are shared between adult family members or other shareholders who are taxed at different rates.

Alphabet shares are simply different classes of ordinary shares (for example, A, B and C shares) with different dividend rights. Instead of paying the same dividend on every share, the company can declare different dividends on each class, provided the shares are properly created and issued.

From a PAYE and tax perspective:

• dividends paid on alphabet shares are still dividends, not remuneration;
• dividends are paid out of profits after corporation tax and are not deductible for corporation tax;
• dividend income is taxed on the shareholder receiving it and does not attract National Insurance;
• dividend income counts towards total income, including the £100,000 threshold for withdrawal of the personal allowance; and
• where shares are held by minor children, dividends above £100 per tax year for that child are taxed as the parent’s income. This rule does not apply to dividends paid to adult children or other adult family members.

Alphabet shares must be authorised by the company’s articles of association and issued in accordance with company law. Poorly documented or informal arrangements may be challenged by HMRC.

Because the tax treatment of alphabet shares depends heavily on the facts and the way the shares are structured and used, director-owners should take professional advice before implementing or relying on an alphabet share structure.

This section is included for general awareness only.

Sources and Further Reading

ITEPA 2003 CTA 2009 HMRC Employment Income Manual (EIM) HMRC National Insurance Manual (NIM) HMRC Pensions Tax Manual (PTM)

Disclaimer

This article provides general information only and does not constitute tax, accounting or legal advice. Taxation rules, PAYE requirements and statutory thresholds may change. The correct treatment depends on the specific facts of each company and its director-owners. Professional advice should be obtained before acting on any of the information contained in this guide.

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Related 2025/26 Director Tax Planning Guides

• UK Taxation for Small Companies & Start-ups (2025/26)
• Supporting Appendix – Full Technical Workings (2025/26)

Supporting Appendix – Full Technical Workings (2025/26) – Full Text With Link Markers