Salary v Dividends Print

A shareholder/director of a limited liability company may choose whether to withdraw profits from his company by voting a salary/bonus or by declaring a dividend. Alternatively, he may opt to leave the profits within the company. In the event that he wishes to withdraw some of the profits for his personal use, he is left with the choice between salary and dividend.

With the rate of corporation tax currently at 19%, and taking into account the amount of National Insurance Contributions (“NIC”) payable by both employees and employers, the overall level of taxation is lowest when dividends are taken. It has not been beneficial to take bonuses for several years.

Example:

Richard is the director, and sole shareholder of his trading company which for the year ending 31 March 2022 makes a profit of £750,000 after paying him an annual salary of

£160,000. He would like to take a bonus or dividend for the year so that in either case he will be left with £300,000 after all income tax and NIC has been paid. He has no other income.

2021/22

Corporation Tax liability:

£566,037 paid wholly as bonus, £ £484,652 paid wholly as dividend, £
Profit for year 750,000 750,000
Deduct bonus 566,037
Employers Nic on bonus 78,113
644,150
Taxable profit 105,850 750,000
Corporation Tax Due @ 19% 20,117 142,500
Cash Flow Comparison:
Profit for Year 750,000 750,000
Deduct Bonus 566,037
Employers NIC 78,113
Dividend 484,652
Corporation Tax 20,111 142,500
664,261 627,152
Retained Profit in Company 85,739 122,848

The retained profit in the company is £37,109 higher after paying the dividend. Each situation should be reviewed carefully before deciding which route to choose.

Richard receives the same net amount equivalent to £300,000 after all tax and NIC is paid, and therefore, his personal tax position is not affected by the method of payment. He may obtain a cash-flow advantage by receiving dividends as the higher rate tax is not payable on a dividend until 31 January in the following tax year. This advantage is reduced by the requirement to make payments on account in respect of the following year’s liability. For example, for the year 2021/22 the tax liability on the dividend of

£484,652 amounts to £184,652, which should be paid by 31 January 2023. At the same time a payment on account for the year 2022/23 becomes due, and this amounts to 50% of the above tax, with a further 50% becoming due by 31 July 2023. Payments on account may be reduced where it is known that the liability will be lower in the second year. A cash-flow advantage may be obtained by delaying payment of any dividends during the period 31 January to 5 April until after 5 April, thus deferring the payment of the higher rate tax for a year. As mentioned above, the date on which a dividend is paid has no effect on the corporation tax liability of the company.

From 1 April 2023 the main rate of corporation tax is being increased to 25% where profits exceed £250,000. Profits up to £50,000 will continue to be charged at 19% with marginal relief on profits between £50,000 and £250,000.

This will reduce, or reverse the tax efficiency of dividends, and to demonstrate this the above example has been recalculated for 2023/24:

2023/24

Corporation Tax liability:

£566,037 paid wholly as bonus, £ £484,652 paid wholly as dividend, £
Profit for year 750,000 750,000
Deduct bonus 566,037
Employers Nic on bonus 78,113
644,150
Taxable profit 105,850 750,000
Corporation Tax Due 24,300 187,500
Cash Flow Comparison:
Profit for Year 750,000 750,000
Deduct Bonus 566,037
Employers NIC 78,113
Dividend 484,652
Corporation Tax 24,300 187,500
668,450 672,152
Retained Profit in Company 81,550 77,848

The retained profit in the company is now £3,702 higher after paying the bonus rather than paying a dividend.

There may be other reasons why a dividend or bonus would be preferable depending on the individual’s circumstances. For example, it may be that dividends are more preferable so that profits may be distributed to family members who are shareholders, but are not employees or directors of the company. Conversely there may be outside shareholders who should only benefit from the company’s profits in excess of an amount to be allocated to the working directors/shareholders.

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