Why a Director's Final Pay Differs from a Standard Employee Termination
When a director leaves your company, the final salary payment is rarely just a matter of running a normal payroll run and issuing a P45. Directors typically have a director's loan account, accrued but untaken dividends, and often a salary that has been set at the personal allowance threshold. Getting the final payment wrong can trigger unnecessary tax charges, director's loan account (DLA) issues, and HMRC penalties for late or incorrect RTI submissions.
This guide covers the practical steps for processing a final salary payment for a leaving director, whether they are resigning, retiring, or being removed. We will work through the payroll mechanics, the DLA adjustments, and the reporting obligations that follow.
Step 1: Confirm the Director's Leaving Date
The leaving date determines everything that follows. For payroll purposes, the leaving date is the last day the director is employed by the company. This is not necessarily the same as the date they stop working. If they have accrued holiday pay that they will take in lieu, the leaving date is the last day of the holiday period, not the last working day.
For a director who is also a shareholder, the leaving date also affects their entitlement to dividends declared after that point. If the company has a dividend policy that pays out after year-end, the leaving director may not be entitled to those dividends unless the board agrees otherwise.
Get the leaving date confirmed in writing, ideally in a board minute or a resignation letter. This gives you a clear record for HMRC and for the final accounts.
Step 2: Calculate the Final Salary Payment
The final salary payment should include:
- Base salary up to the leaving date, paid at the normal rate.
- Accrued holiday pay that has not been taken. Directors are entitled to 5.6 weeks statutory holiday per year. If they have not taken all their entitlement, you must pay it in the final payment. This is treated as earnings and is subject to tax and NI in the usual way.
- Any contractual bonuses or commissions that have been earned but not yet paid. These are also earnings and subject to tax and NI.
- Notice pay if the director is leaving without working their full notice period. Statutory notice pay is treated as earnings and taxed through payroll. Contractual notice pay above the statutory minimum may be treated differently, but the default is to process it through payroll unless a specific termination payment applies.
Do not include any share-based payments or dividends in the salary payment. Those are separate transactions with their own tax treatment.
Example: Final Salary Calculation
A director in a Birmingham-based consultancy leaves on 15 June 2025. Their annual salary is £12,570, paid monthly at £1,047.50. They have 10 days accrued but untaken holiday. Their final salary payment is:
- Base salary for 15 days: £523.75
- Accrued holiday pay (10 days at £57.70 per day): £577.00
- Total gross payment: £1,100.75
This total is subject to PAYE tax and NI in the normal way. Because the director's total earnings for the tax year to date are still below the personal allowance and NI thresholds, no tax or NI is due on this payment. But you still need to report it through RTI.
Step 3: Reconcile the Director's Loan Account
This is where most mistakes happen. A director's loan account tracks money owed between the director and the company. If the director has taken more from the company than they have put in (salary, dividends, expenses), they owe the company money. If the company owes them money (undrawn salary, dividends declared but not paid), the company owes the director.
When a director leaves, you must clear the DLA balance. Here is how to handle the common scenarios:
Scenario A: The Director Owes the Company Money
If the DLA is overdrawn (the director owes the company), the company can deduct the amount from the final salary payment, provided the director agrees in writing. This is a repayment of a loan, not a salary payment, so it is not subject to tax or NI. The company should issue a repayment receipt and update the DLA records accordingly.
If the final salary is not enough to clear the DLA, the director must repay the balance directly to the company. If they do not, the company faces a Section 455 charge of 33.75% on the outstanding amount. This charge is reclaimable once the loan is repaid, but it creates a cash flow problem.
Scenario B: The Company Owes the Director Money
If the DLA is in credit (the company owes the director), the company can pay the balance as part of the final settlement. This payment is not salary; it is a repayment of a debt. It is not subject to tax or NI, but it must be recorded in the accounts as a repayment of the director's loan account, not as a salary expense.
If the company pays the DLA credit as salary by mistake, it becomes subject to tax and NI, which is an unnecessary cost.
Scenario C: Mixed Balances
Sometimes the DLA has both salary and loan elements. The safest approach is to:
- Process the final salary payment through payroll first.
- Settle any remaining DLA balance separately, either by repayment (director owes company) or by payment (company owes director).
- Document both transactions clearly in the company's books.
Step 4: Process the Final Payroll Run
Once you have the final salary figure and the DLA reconciled, run the final payroll. Use your payroll software (Xero, FreeAgent, QuickBooks, Sage 50, or BrightPay) and:
- Enter the leaving date in the employee record.
- Process the final payment as a normal payroll run, applying tax and NI in the usual way.
- Submit the Full Payment Submission (FPS) to HMRC on or before the payment date. This is an RTI requirement. If you miss the deadline, HMRC may issue a penalty.
- Generate the P45. The software should produce this automatically. The P45 shows the total pay and tax to date for the tax year. The director needs this for their next employer or for their self assessment return.
If the director is also a company employee (not just a director), the same process applies. The P45 is the same for directors and employees.
What About the P11D?
If the director had any benefits in kind (company car, private medical insurance, beneficial loan) during the tax year, you must report these on a P11D form after the end of the tax year. The leaving date does not change this obligation. The P11D covers the period from 6 April to the leaving date.
You also need to submit a P11D(b) for the Class 1A NIC due on those benefits. This is due by 6 July after the end of the tax year.
Step 5: Update the Company Records and Accounts
After the payroll is processed, update the company's statutory records:
- Register of directors: Record the resignation or removal date. File a TM01 form (termination of appointment of director) with Companies House within 14 days.
- Register of members: If the director is also a shareholder, their shareholding remains unless they sell or transfer their shares. Update the register if shares are transferred.
- Annual accounts: The final salary payment and any DLA settlement will appear in the year-end accounts. If the leaving date falls partway through the accounting period, apportion salary and dividends accordingly.
The final salary payment is a deductible expense for corporation tax purposes, provided it is wholly and exclusively for the purposes of the trade. Accrued holiday pay and contractual bonuses are also deductible. Notice pay is deductible if it is contractual or statutory.
Common Mistakes to Avoid
Mistake 1: Forgetting the Director's Loan Account
Leaving the DLA unresolved creates a Section 455 charge and can lead to HMRC enquiries. Always reconcile the DLA before processing the final payment.
Mistake 2: Paying the DLA Credit as Salary
If the company owes the director money, paying it as salary triggers unnecessary tax and NI. Pay it as a loan repayment instead.
Mistake 3: Missing the RTI Deadline
The FPS must be submitted on or before the payment date. If you process the payment on 30 June, submit the FPS by 30 June. Late submissions can attract penalties starting at £100 per month.
Mistake 4: Incorrect P45 Issuance
The P45 must show the correct leaving date and cumulative pay and tax. If the director has multiple employments with the same company (e.g., director and employee), ensure the P45 reflects the correct employment.
Mistake 5: Ignoring Accrued Holiday Pay
Directors are entitled to statutory holiday pay. If you do not pay accrued holiday in the final payment, the director can claim it through an employment tribunal. Pay it as part of the final salary.
What If the Director Is Also a Shareholder?
If the leaving director holds shares, their departure does not automatically trigger a share transfer. They remain a shareholder unless they sell or transfer their shares. The company's articles of association may include a compulsory transfer provision for departing directors, but this is not automatic.
If the director sells their shares, that is a separate capital gains tax event. The sale proceeds are not part of the final salary payment. The director may qualify for Business Asset Disposal Relief (BADR) if they have held the shares for at least two years and meet the other conditions. The current BADR rate is 14% for disposals from 6 April 2025, rising to 18% from 6 April 2026.
If the company buys back the shares, that is a purchase of own shares transaction with its own tax and legal requirements. Do not confuse this with a salary payment.
What About Dividends Declared After the Leaving Date?
If the company declares a dividend after the director has left, the leaving director is not entitled to it unless the board resolves otherwise. The dividend is payable only to shareholders on the register at the date of declaration. If the leaving director is still a shareholder, they are entitled to the dividend. If they have sold their shares, they are not.
If the company wants to pay a leaving dividend to the departing director as a goodwill gesture, that is a separate dividend declaration, not part of the final salary payment. It must be declared in the usual way and paid out of distributable profits.
Final Checks Before You Pay
Before you release the final payment, run through this checklist:
- Leaving date confirmed in writing.
- Final salary calculated including accrued holiday pay.
- Director's loan account reconciled and settled.
- Payroll run processed with correct leaving date.
- FPS submitted to HMRC on time.
- P45 generated and issued to the director.
- TM01 form filed with Companies House.
- Register of directors updated.
- Shareholder position documented (if applicable).
- Benefits in kind noted for P11D reporting.
If you are unsure about any step, speak to your accountant. As ICAEW qualified accountants, we handle director departures regularly. The key is to separate the salary payment from the DLA settlement and the share transaction. Mixing them up creates tax problems that are costly to unwind.
For a full list of our services, including payroll and company secretarial support, visit our services page. If you need to discuss a specific director departure, contact our team.