Until 1 April 2023 it was fairly standard tax planning for the director and shareholders of owner-managed companies to take a salary within the tax-free or national insurance-free bands, and any further remuneration by way of dividends. However, the changes to tax rates mean owner-managed businesses may need to reconsider the mix of salary and dividends to achieve the optimum remuneration strategy.
Dividends are an option only if the company has been profitable and has retained earnings to distribute
The main corporation tax rate has increased from 1 April 2023. The rate remains 19% for taxable profit up to £50,000, but is now 25% for companies with profit over £250,000.
The £250,000 threshold is divided by the number of group companies and any other companies under common control, plus one. For profits between £50,000 and £250,000, marginal relief applies. The effective rate of corporation tax therefore increases gradually from 19% to 25% for profits between these two thresholds.
Rate changes
With so many tax rate changes coming in, it is worth summarising where we now are.
The proposed health and social care levy has been scrapped, so national insurance rates have reverted to where they were at the start of 2022/23. However, dividend rates remain 1.25% higher than in 2021/22.
Various chancellors have announced the alignment of the primary and secondary thresholds, only for them to fall out of sync again shortly afterwards. Currently there is a large gap between the two thresholds.
When the company is a 19% taxpayer, the dividend route is more efficient
Between £9,100 and £12,570, a company pays national insurance at 13.8%, but the employee has no primary contribution liability. The company will get a corporation tax saving on the salary plus national insurance at a rate of at least 19%. So overall, an owner-managed business is likely to be better off paying a salary at the primary threshold of £12,570 and incurring a small secondary liability on earnings between £9,100 and £12,570. However, this will depend on the personal circumstances of the person receiving the salary.
A salary of £12,570 a year has a total national insurance liability of £478.86. If the company is already paying a salary up to the secondary threshold of £9,100, this additional salary saves at least another £750.28 in corporation tax. So overall, there is a saving of around £270 a year by paying this level of salary.
But above this amount, is it more tax-efficient to pay a dividend or a bonus? Dividends are an option only if the company has been profitable and has retained earnings to distribute.
Salary recap
A few reminders about salaries:
- A salary/bonus is tax-deductible if paid wholly and exclusively for the purposes of the business.
- A bonus is eligible for a corporation tax deduction if paid within nine months of the end of the accounting period in which it accrues.
- The date a salary is taxable on the recipient is generally the date when the salary is paid to the recipient or they become entitled to it.
- For a director, a salary may also be considered received on the date it is credited to the company’s accounts or the date the salary amount is determined (if this is for the current accounting period, the date is taken as the accounting period end date).
- Salaries are paid for a specific period. If an employee is not a UK resident during that period, the salary may not be taxable in the UK, even if it is received when they are subsequently UK-resident.
It will always be worth utilising the £1,000 dividend allowance if reserves allow
Let’s take a very basic example of an owner-managed company with £100,000 in cash available to pay either a salary or a dividend. The tax efficiency of each route depends on whether the company is paying tax at 19% or 25% (for simplicity, we’ll ignore the marginal rates that may also apply).
The interaction of the income tax and national insurance due plus the corporation tax savings on salaries means it can be more efficient to pay a salary than a dividend when the company is a 25% corporation taxpayer. When the company is a 19% taxpayer, the dividend route is more efficient.
There may also be other factors to consider – for example, any losses in the company or incurred personally. It will always be worth utilising the £1,000 dividend allowance if reserves allow.
Other factors
Do not be driven solely by the tax position of dividends or salaries. Other factors to consider include:
- Employer pension contributions are also eligible for a corporation tax deduction and are not charged to tax on the employee. That makes them an efficient way to extract profits from a company, particularly with the proposed increase in the annual allowance to £60,000.
- Tax-efficient benefits such as electric cars can also feature in a remuneration package.
- Taking a salary reduces EBITDA, which could impact the company’s ability to borrow.
- Anyone in the midst of an earn-out period that relies on EBITDA could be impacted by taking a bonus rather than a dividend.
- HMRC does not like employees swapping salaries for dividends, and won a 2011 appeal against PA Holdings on the issue. If a director/shareholder starts taking a bigger regular salary but it becomes more efficient to switch back to dividends in a subsequent year, HMRC may demand employment taxes on the dividends.
- Tax and national insurance on salaries/bonuses is due immediately via PAYE, whereas the tax on dividends has the cashflow benefit of being payable via self-assessment.
Always review the position in detail with your clients, taking into account the likely profitability of the company and the individual’s personal circumstances. Tax advice should never be the sole focus, and strategies should also be considered from a commercial angle.
