Salary, dividend or both?
Let’s set the scene. You’re down the pub and someone says, "A limited company is the way to go. Take dividends instead of salary and you'll pay less tax!”
Fast forward a couple of weeks, the company name has been chosen, incorporation documents have all been received from Companies House, and you’re busy trading.
However, after discussing with an expert (this is where we step in), you realise that the company is a separate legal entity, and that transferring all the profits into your personal account each month might have some tax implications that you hadn’t considered.
But what’s the most tax efficient way of the company paying you, the employee? Is it salary, dividend or something else? The short answer is, it depends.
Points to consider
Directors can choose to take a low salary, attracting no National Insurance and still qualifying for pension, sickness and other benefits.
Dividends are taxed at different rates, dependant on your level of income. If you’re a basic rate taxpayer (for 2023/24 earning up to £50,270), dividend income is taxed at 8.75% compared to the income tax rate of 20%.
Dividends are paid from post-tax profits, whilst salary is paid from pre-tax profits, so reduces the profits subject to corporation tax. The rates of corporation tax have changed from 1 April 2023. It’s important to understand what profits are available to pay dividends, and whether paying a higher salary could reduce your overall tax liabilities.
Another element to your remuneration package may be pension contributions paid by the company, which are also allowable for corporation tax purposes.
On 1 April 2023, the main rate of corporation tax increased to 25%. Director salaries are generally deductible from taxable profits, if incurred wholly and exclusively for the purpose of the trade. To reduce the impact of the increase in corporation tax, you could consider having a market rate salary for the role that you’re doing. Similarly, if you’ve been trading for some time, but your director salary has remained the same, it may be time to review this.
Another consideration is whether all those involved in running the business are being remunerated for their work, for example, spouses often take on an administrative role in the business, by remunerating them for that work, you could make better use of all available allowances and tax bands. If the individual isn’t a director of the company, their salary level will be affected by the National Minimum Wage rules. Maintaining a record of hours worked is also recommended.
The potential corporation tax saving of paying increased salaries needs to be compared to an increase in PAYE and NIC costs, as well as the cashflow implications of meeting those liabilities.
To declare dividends, the company must be making sufficient profits. Accurate management information is imperative, as keeping track of monthly performance (after tax) will determine the level of dividends that can be paid. If dividends declared exceed available profits and result in an insolvent balance sheet, the dividends will be illegal and need to be repaid to the company.
The tax-free dividend allowance still exists, although it’s reduced for 2023/24 to £1,000 (2022/23 - £2,000).
Dividend vouchers and supporting minutes of meetings when declaring dividends should be prepared, signed, and retained in the statutory records.
When will the tax become payable? PAYE is usually payable monthly to HMRC. Dividend income is included on an individual’s Self Assessment tax return, and any Income Tax liability is payable by 31 January after the tax year ends, unless you’re also required to make payments on account.
Can the company benefit from claiming the Employment Allowance against NIC costs? If eligible, employers can claim up to £5,000 against the NIC liability.
What are the future cashflow requirements of the company? Maintaining working capital or retaining cash in the business to invest in the future may prevent you declaring significant dividends or bonuses.
Are there Child Benefit implications for the individual? If the level of income of the individual exceeds £50,000, a High Income Child Benefit Charge will arise.
Will you need to demonstrate a regular income for obtaining a mortgage? Lenders may not view dividends as favourably when reviewing applications.
Are you involved in research and development and eligible to claim relief for costs incurred? If you’re involved in conducting the research, a proportion of your salary cost can be claimed. If you were remunerated via dividends, these would not be eligible as part of the claim.
There are many other aspects to consider, and whilst we know that 'it depends' is a frustrating response when you’re busy running a business, investing time in consulting an expert could be invaluable. How you extract money from your business is something to consider every year as tax rates and other circumstances change, making sure you’re getting the most from all your hard work.
If you need further advice and support in running your business, please get in touch with your usual contact. You can find contact details in the Our People section of the website. Alternatively, call 0330 024 0888 or email email@example.com.
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