Business owners have two main options in deciding how to take remuneration from their company: salary or dividend? But which is the most tax efficient?

Salary versus dividends

Salaries and bonuses paid to a director are processed through the company’s payroll, just like any other employee, and are liable to PAYE income tax and employee and employer National Insurance Contributions (NICs).

Salaries, bonuses and the associated employer NIC liabilities are deductible in calculating the company’s profits which are chargeable to corporation tax.

Dividends are payments to shareholders out of the company’s profits after tax and are not deductible in calculating the company’s taxable profits. Dividends are taxed as investment income and are not subject to NICs.

Historically, dividends have been more tax-efficient than taking salary and bonuses, and shareholder-directors often opted to take a small salary from their company equal to the personal allowance, and took the balance of their remuneration by way of dividends. However, changes to corporation tax rates, the reduction of the 0% dividend allowance to £500 in the current 2024/25 tax year, and recent reductions in NICs in January 2024 and March 2024, mean that business owners should re-evaluate how they take their remuneration.

Basic rate and higher rate taxpayers

For basic rate taxpayers, taking dividends will generally remains more tax-efficient than taking salary, though a salary that is at least equal to their available personal allowance is typically advantageous if they have no other sources of income.

Higher rate taxpayers

A salary/bonus combination will generally be more tax efficient for higher rate and additional rate taxpayers if the corporation tax rate of their company is above 19%.

The first £50,000 of profits are taxable at the small companies’ corporation tax rate of 19%, while profits in excess of £250,000 are taxed at the main rate of 25%. Profits falling between these two thresholds are taxed at 26.5%. These thresholds are reduced if there are any associated companies.

Other variables

These are generalisations and there are a great number of other variables that can affect the outcome of any remuneration calculations.

For example:

· the impact of pension contributions;

· other income including rental and investment income;

· implications of tax on other benefits in kind provided by the company, e.g., company cars;

· how the remuneration may impact eligibility for tax credits (Child Tax Credit, Working Tax Credit), child benefit and other means-tested benefits.

· other ways of extracting income from the business for example through rent (if the business operates from premises that the director owns personally) and loan interest (if the director has made loans to the company).

The wider view

It is important to place remuneration planning in the context of a more holistic view of your overall financial well-being, in particular:

· for retirement planning, the pensions regime remains a very favourable one;

· you should consider the terms of any life insurance and similar policies to ensure they cover dividend income and not just salary;

· there are also circumstances to consider in which a regular salaried income is important for example, obtaining a mortgage.

In short, there are many factors to consider when considering the most tax efficient way to take remuneration and professional advice should be taken to evaluate your own personal circumstances.