Dividend or salary/bonus/PAYE
If you are operating your business as a limited company, the issue of tax efficient withdrawal of funds is often discussed by tax advisor and accountants with there clients. These discussions and the decisions made can change depending on the current tax rules and rates.
Corporation tax rate changes have been the most recent factor to impact the dividend v salary decision.
Dividend or salary/bonus
Many business owners and company directors will look to extract funds from the company in the most tax efficient way. This article considers the factors which impact upon the cost of providing a dividend or bonus by a company, to a shareholder/director.
Overview of the company position of providing a bonus
The first consideration needs to be the tax and National Insurance position of the director/shareholder to determine the pre tax cost of the bonus. This depends on:
• the tax position of the director – ie basic or higher rate taxpayer
• the rate of employee National Insurance (NIC) – 1% where the director already has remuneration with the employer which exceeds the upper limit for the main rate of NIC or 11% where that limit has not yet been reached.
The second consideration for the company is to allow for the additional employer NIC cost, currently charged at 12.8%.
All costs are then reduced depending on the corporation tax rate of the company. This primarily depends on the level of company profits but other factors may affect the exact corporation tax rate in a company’s circumstances so advice is recommended.
To demonstrate how this might operate the illustration below assumes:
• the director is a higher rate payer
• the relevant rate of employee National Insurance is only 1%
• the aim is to provide a director with £10,000 after the deductions for the higher rate tax of 40% and the NIC cost of 1%
• employer NIC is 12.8%.
The £10,000 received by the director has to first be grossed up for the tax and NIC: £10,000 x 100/59 = £16,949.
Then the employer NIC of 12.8% is added to this to find the total pre tax cost: £16,949 x 112.8/100 = £19,118
The true cost to the company is now determined by the corporation tax rate saving. The following table uses the effective corporation tax rates, at different profit levels, for a single company for the period 1 April 2008 to 31 March 2009.
| Profits || less than 300k ||more than 1.5 mill ||300k-1.5mill |
| Rate of corporation tax ||21% ||28% ||29.75% |
| Cost before CT saving ||£19,118 ||£19,118 ||£19,118 |
| Tax relief for company @ 21% / 28% / 29.75% ||(£4,015) ||(£5,353) ||(£5,688) |
| Net overall cost ||£15,103||£13,765 ||£13,430 |
Cost comparison - dividend route
The cost of the company is solely determined by the income tax position of the director/shareholder. The only direct outlay of the company is the dividend payment. There is no additional NIC cost for either the employee or employer on a dividend but there is no CT relief saving either.
Assuming again that the individual is a higher rate taxpayer then on receipt of a cash dividend, 25% effectively needs to be retained to pay the higher rate tax.
If a dividend of£13,333 is paid then, after settling the 25% tax £10,000 cash will be available. As can be seen from the table above, in the current financial year this is currently a cheaper cost alternative compared to a bonus whatever the rate of company tax.
There are a range of other considerations aside from the numerical comparisons which may need to be borne in mind. These include but are not limited to:
• the status and needs of other shareholders
• other profit extraction methods such as pension provision and rent
• preserving minimum NICs for the state retirement pension
• the possible impact on share valuation of regular dividend payments
• the impact of proposed income shifting legislation.