Are dividends more tax efficient than a salary?

For many years, owners of limited companies have chosen to remunerate themselves by way of dividends rather than salary. The fact that dividends do not attract national insurance and that corporation tax rates have been as low as 19% has caused this approach to be widely adopted in recent times.

However, more recently we have seen the highest rate of corporation tax increase to 26.5% in certain circumstances and the rate of National Insurance (NI) for employees has been cut. Given that the ‘rules of the game’ have changed, we need to consider whether any remuneration plans that are in place still represent the best way forward.

For example, let’s consider a shareholder/director who pays themselves a salary of £60,000p.a. They work for a profitable company that makes profits of £160,000p.a. and therefore pays corporation tax at a marginal rate of 26.5%. The company has performed well and has made an additional windfall profit of £30,000 due to the efforts of this individual. If this additional amount is to be directed to the individual concerned, should it be paid as a bonus or a dividend, in addition to the existing salary?

If a bonus is paid, then the bonus will attract employer’s NI at 13.8%. If the bonus is £26,362 then the employer’s NI charge will be £3,638. Together, these amounts will wipe out the windfall profit of £30,000.

As a higher rate tax-payer the individual will also suffer income tax at 40% = £10,545 and employee’s NI at 2% = £527.

The individual will take home £15,290 of the £30,000 windfall profit.

Alternatively, if a dividend is paid, then the £30,000 windfall profit will first be subject to Corporation Tax at 26.5% = £7,950. The shareholder director will then receive a dividend of £22,050. This amount will be subject to higher rate dividend tax at 33.75% = £7,442.

The individual will take home £14,608 of the £30,000 windfall profit.

As you can see in this very simplistic example, it is actually advantageous for the individual to take the salary rather than the dividend. The differential is even more apparent where individuals are above the state pension age and therefore do not suffer employee’s NI. In addition, for companies where Research and Development Tax Credits are available there is a further incentive to pay salary rather than dividends.

As always, everyone’s situation is different and there are many factors to consider when deciding upon a remuneration strategy. As such, professional advice is a must.