For some time, it has generally been the case that dividends have offered company owners and directors a cost effective and flexible remuneration option compared to a bonus or salary.
However, the gap between the two has narrowed in the past few years, and with the recent Corporation Tax rise from 19% flat rate to an upper rate of 25%, it can no longer be assumed that a simple dividend option is the most effective route to take for owners and directors’ remuneration.
With a new personal tax year recently starting, now is an ideal time for directors and shareholders to assess their remuneration plans.
Tax effective remuneration
Regular planning is undertaken to help entrepreneurs, business owners and directors to extract profit from the business in a tax efficient way. There are a few ways this can be done, but the most commonly used options are through dividends or via a standard salary/bonus scheme. It is also common to see a blend of the two routes – depending on the personal and business circumstances of the director/shareholder.
The ability to pay dividends relies upon the company earning profit after tax in excess of the amount of dividends to be paid. Dividends are not subject to National Insurance Contributions (NICs), and have been viewed as a more attractive way of extracting money compared to salary. Dividends, however, do not reduce a company’s Corporation Tax bill as they are paid out of the company profits after tax.
In terms of income tax, it is taxed at the dividend rate of income tax for the individual. The basic tax rate on company dividends is 8.75%, the higher rate is 33.75%, and the additional rate is 39.35%. The tax due for a dividend paid in 2023/24 would be payable via self-assessment on 31 January 2025, except for where payments on account are needed on 31 January 2024 and 31 July 2024.
It can also be beneficial to receive pay via bonus/salary as this allows the individual to build qualifying years towards their state pension, and to make higher pension contributions if they wish to do so. From a business perspective, the amount of corporation tax which the company pays would be reduced compared to receiving pay via dividends. Unlike dividends, however, there will be NICs due from both the individual and the company, and a higher rate of income tax will be payable by the individual.
The business will be able to claim corporation tax relief on the NICs and bonus/salary it has paid, so it can deduct both when calculating profits, which are subject to corporation tax.
We have seen many directors and shareholders who have paid themselves a minimal salary (up to the general threshold for NICs) and then rely on dividends for the balance of their income. Recent changes in tax rates have made this approach more complex, meaning extra calculations and diligence is required as well as seeking specialist advice before going down this route.
Is there a clear cut answer?
Simply, every individual’s personal and business circumstances are different. If you add into this the following tax changes coming into play in this new tax year, there are a number of influencing factors:
- Corporation Tax – Increased from flat 19% rate on all taxable profits to 19% on taxable profits up to £50,000 and 25% for taxable profits over £250,000
- Marginal Corporation Tax rate – Effective rate of 26.5% on taxable profits falling between £50,000 and £250,000
- Income Tax
- Tax-free Dividend Allowance cut by 50% to £1,000
- Additional (45%/47%) Rate threshold cut from £150,000 to £125,140
- Personal Allowances frozen
- Scottish residents – Remains more complex as Income Tax rates are up to 2% higher within each band and there are five instead of three rate bandings.
The most effective remuneration plan will also be affected by ancillary matters such as age (no National Insurance for those over 65), pension contributions, salary sacrifice arrangements and benefits in kind.
If you haven’t reviewed your remuneration recently we urge you to do so now to make sure you have the right plan for your circumstances, particularly in view of the significant increase in complexity of the tax system and the effective increase in tax rates.
We are here to help
If you have any questions relating to which option is best for you or would like to discuss tax efficient remuneration planning, please get in touch with a member of our specialist team.