One of the perceived significant benefits of incorporation is the ability to extract profits from the company through dividends.
The main advantage is the National Insurance saving, as no NICs are payable on dividends. In contrast, a salary payment would attract employee NICs of 13.25% or 3.25% and employer NICs of 15.05% (2022/23 figures) once the salary exceeds the primary and secondary thresholds.
Tax on dividends in the hands of the recipient
All taxpayers receive a dividend ‘allowance’, regardless of their marginal tax rate. This dividend allowance is set at c for 2022/23. However, this is not an ‘allowance’ but rather a zero-rate band that taxes the first £2,000 of taxable dividend income at a rate of 0%. Thereafter, for 2022/23, dividends are taxed at 8.75% to the extent that they fall within the basic rate band, 33.75% to the extent that they fall within the higher rate band, and 39.35% to the extent that they fall within the additional rate band. The dividend tax rates are increased by 1.25 percentage points from 6 April 2022 to provide funding for health and adult social care.
Tax on Salary in the hands of the recipient
Payment of salary will attract tax at the taxpayer’s marginal rate of income tax (20%, 40%, or 45% (or, for Scottish taxpayers, at the relevant Scottish rate)).
Salary payments are deductible in calculating profit for corporation tax purposes, unlike dividends which must be paid out of after-tax profits.
Further, a dividend can only be paid if there are sufficient retained profits. In addition, various company law requirements must be met.
It is not simply a case that dividends are always best, although in many cases, taking dividends will result in less tax and National Insurance than taking a salary payment.
However, the best result will depend on the circumstances, as the decision whether to take salary or dividends will depend on the interaction of various factors – respective rates of income tax, corporation tax and National Insurance contributions, and any other income that the taxpayer has and whether the company has sufficient retained profits.
Case study: Remuneration or Dividend?
Paul is the director of a small company. He has profits of £20,000 (before corporation tax) and wants to know whether to extract them through a salary or a dividend. It is assumed that he has already received a small salary equal to his personal allowance.
He has a small number of employees and has utilized
the NIC employment allowance in respect of the employer’s NIC payable in respect of earnings paid to his employees.
Less Employer’s NIC @15.05% (£2,616)
Available to pay as salary £17,384
Less Income Tax @ 20% (£3,477)
Less NIC @ 13.25% (£2,303)
Retained by shareholder £11,604
There is no corporation tax to pay as taxable profits are reduced to nil after deducting a salary of £17,384 and the employer’s NIC on that salary of £2,616.
Less Corporation Tax @ 19% (£3,800)
Distributed as a dividend £16,200
Income Tax (£1,242)
Retained by shareholder £14,958
The dividend falls within the basic rate band (£37,700 for 2022/23). The first £2,000 of the dividend is taxed at 0%, and the remaining £14,200 is taxed at 8.75%. The total tax payable on the dividend is therefore £1,242 ((£2,000 @ 0%) + (£14,200 @ 8.75%)).
In this situation, Paul is better off by paying a dividend as he can retain £14,958 of the profits, as compared to retaining only £11,604 if they are extracted by salary payment.
We can help you
This is a very complex area, and if you are affected by this, you should contact us so we can help you navigate this change in good time and with the least amount of difficulty.