Dividend, salary, bonus or capital – which mix is best for tax?

When profits reach a certain level, trading through a limited company can certainly have its tax perks, primarily, due to benefits from the lower rate of corporation tax, currently 21% and 20% for small companies. In addition, tax rates can be favorable personally, for directors and shareholders, provided the right methods are used to extract the cash. With the option of dividends, salaries and bonuses for starters, a little thought it required.

It’s important to get the right advice

Depending on how long you have been in business will depend whether this is familiar territory to you or not. It is surprising though that even long established business owners can get this very wrong or take bad advice around this subject, which often results in additional and unnecessary tax payments. Landsell & Rose can carry out a bespoke tax assessment for you.

A bit about dividends

Dividends are recognised as an economical way to withdraw company cash. A 10% tax credit applies, there is no related National Insurance (NI) and essentially dividends are tax free to the basic rate threshold, which for 14/15 is £31,865. Withdrawals over this basic rate threshold are subject to tax, as follows:
  • £0 – £31,865 – 0% tax (basic rate)
  • £31,865 – £150,000  (about 25% after the tax credit)
  • £150,000+  (about 30% after the tax credit)
These rates though are still very competitive against the higher rates of income tax, which currently stand at 40% and 45%.

A bit about salaries and bonuses

Salaries and bonuses fall within the realm of income tax so unfortunately these lower rates of tax do not apply.  After the personal allowance (14/15: £10,000) the basic rate of income tax is 20% up to £31,865 (14/15). In addition NI applies for both the employee, i.e. you and the employer, i.e. your company, so it can be a more costly option.

So why not just take all remuneration as dividends?

First of all there is a plus side to drawing salaries and bonuses because they are eligible for full tax relief for the limited company, unlike dividends. The NI is also eligible. However, certainly a remuneration package taking advantage of the lower rate of tax on dividends is common for overall tax planning. A couple of considerations worth noting though:
  • Firstly, dividends must be paid according to the shareholding and this can cause restrictions when allocating profits between directors and shareholders. There is more flexibility with cash extraction via salaries and bonuses as they can be provided with the individual in mind.
  • Secondly, any payment of dividends must be made from retained profits. In other words, the company needs to have enough funds to pay the dividend. Salaries and bonuses work differently.
 

A tax efficient dividend and salary combination

Assuming the above points are not relevant though and typical circumstances apply, a director and shareholder of a small company could receive a minimum salary of somewhere between £109 and £148 per week (14/15) taking them just under or just above the NI limit, followed by dividends to the basic rate threshold. Factoring in the personal allowance of £10,000 means that:

Around £38,500 can be extracted with a zero personal tax position.

This alone suits many business owners, especially if they have other sources of income or if they are part of a family business, being able to double this income “set up” into the same household. Additional funds can be drawn as dividends too. Although tax will be due it will be at a lower rate compared to income tax.

Withdrawing cash via capital extraction

Whilst this is not common like the use of dividends, salaries and bonuses, it’s worth a mention, specifically if you are looking to cease trading when the options for capital extraction widen. The benefits of this method relate again to taking advantage of low tax rates. Capital Gains Tax (CGT) is currently 18% and 28% with good annual allowances, 14/15: £10,900. Anything related to capital extraction methods require the help of an accountant, as things can get tricky. To speak with a qualified accountant regarding the best way to extract money from your limited company or for help with setting up a new company for tax planning purposes, call the Figurit team today: 020 7376 9333