Insights

Corporation tax was increased to 25% on 1 April 2023 and this change, together with previous changes to the way dividends are taxed, mean that decisions about remuneration have become much more complex for company directors and shareholders; it has become a bit of a minefield.

Generally dividends are still more tax efficient than salaries but there are a number of considerations. Dividends are not deductible for the company in calculating the corporation tax liability, but they do not attract national insurance contributions for either the company or the individual, and they are taxed at a lower rate of income tax.

Different circumstances will give rise to different tax outcomes therefore we advise all director shareholders of small and medium sized companies to consider the options and engage in some tax planning to optimise the way they take dividends and salary.

This article explains the nuances of the tax implications and how the amounts of tax payable can vary significantly depending on the position.

Key points to note about corporation tax payments from 1 April 2023

• All companies with profits over £250,000 pay corporation tax at 25%;
• All companies with profits under £50,000 pay the original rate of 19%;
• Companies making profits between £50,000 and £250,000 are taxed at a marginal rate of 26.5% on those profits.

At the same time, dividend tax has changed; the rates have remained the same as the 2021/22 tax year, but the annual tax free allowance has reduced to £1,000.

Income tax thresholds have also remained the same as the previous year, with individual personal allowances also frozen, having the effect of bringing more people into higher rates of taxation.

What does all this mean for a company director shareholder?

Examples showing how dividend payments can be optimised for company shareholders

The best way to understand the implications of these changes is with examples to highlight how tax is deducted based on different income levels and types of income. Slightly counterintuitively, it can be more tax advantageous to take a smaller dividend and a small salary to achieve the same overall income. Here’s why:

Example 1
Jane is a graphic designer owning her own limited company. Her profits exceed the £250K threshold and her company pays 25% corporation tax. She requires an annual net income of at least £85,000 to meet her financial commitments and has asked her accountants to investigate how she can achieve this whilst minimising the personal and corporate tax liabilities.

Salary only
If she takes a £150,000 salary, Jane will take home £85,920, paying tax and NIC of £64,080. The cost to the company if Jane takes a £150,000 gross salary is £127,083, after deducting corporation tax relief.

Salary and large dividend
An alternative approach would be to structure a gross income of £150,000 as a salary of £10,000 and dividends of £140,000. It means Jane does not pay NICs and her tax liability reduces to £43,608. Her net income will increase to £106,392. Sounds good - but consider the cost to her company; the company must pay £147,593 for Jane to receive this level of income. So Jane’s net income increases by £20,472 and the cost to the company increases by a similar amount of £20,510.

Salary and optimised dividend
A more tax efficient approach is to calculate the optimal point at which Jane is able to achieve her desired income level of £85,000. By taking a slightly lower dividend of £120,000 and the same £10,000 salary, Jane can achieve a higher net income of £94,262 and the cost to the company is almost the same as if she took the original £150,000 salary. It means the company can retain more profits without being penalised.

Example 2
Bill is a chef, and he owns a catering company which has profits in excess of £250,000. He would like to achieve a net income of at least £80,000.

Salary only
Taking a £125,000 salary will generate a £76,459 net income, leaving Bill short of his target and the cost to his company will be £105,746.

Salary and dividend
If Bill switches to a £10,000 salary and £115,000 dividend, he will increase his net income to £91,253 but the cost to his company is considerable. The taxes payable by the company will be £122,593. This means the company will lose £20,000 in profits that could otherwise be re-invested into new kitchen equipment which will attract capital allowances tax relief.

Salary and optimised dividend
By cutting back Bill’s dividend to £98,000 with the same £10,000 salary he can achieve a £83,794 net income and the cost to his company is £105,595. He can earn what he needs financially for his family, and he saves his company almost £20,000 – he can buy the new equipment and still received his desired income.

As these two examples show, it is important to carefully consider the right amount of dividend to minimise the tax implications because less can definitely mean more in these circumstances.

By carefully optimising the level of dividend taken, both these taxpayers have achieved the incomes they needed with a significant personal tax saving. Importantly, they have also left their companies in better shape financially.

The government has tinkered with income tax, personal allowances, corporate taxes and dividend allowances a lot over the last few years in an attempt to increase Treasury revenues. This has created an increased level of complexity. The result is that the way in which income is structured for maximum tax efficiency can be counterintuitive and dividends need to be optimised. If you would like us to advise on your particular circumstances, please email us via partners@rjp.co.uk.